Back to School: Circuit Courts Provide “Cheat-Sheet” on Stern Consent Issues in Advance of the Supreme Court’s Consideration of Wellness Int’l Network v. Sharif

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Co-authored by Kyle J. Ortiz and Doron P. Kenter.

“Okay. Here we go. The short, short version.” – The Minister, Spaceballs

“I meant what I said and I said what I meant.” – Horton Hatches the Egg, Dr. Seuss

Remember CliffsNotes? (It’s ok – you can admit it now.) Well, in the two months since the Supreme Court granted certiorari in Wellness Int’l Network v. Sharif to (hopefully) address the question of whether parties can waive their “right” to have an Article III court adjudicate “Stern claims” (and, perhaps, non-core claims), two circuit courts of appeal have taken it upon themselves to save the uninitiated the trouble of the brief research required to find and read their earlier decisions giving rise to the still-extant circuit split. Last month, we reported on the Ninth Circuit Court of Appeals’ decision in GBBY EWA Ltd., P’ship, where that court reiterated its prior position that the right to Article III adjudication can be waived by consent of the parties – whether that consent is expressly granted or simply implied by virtue of the parties’ conduct. Now, in its own CliffsNotes-style memo to the Supreme Court, the Fifth Circuit Court of Appeals reminds us of its position (which it shares with the Sixth and Seventh Circuits) that the right to Article III adjudication is structural, and thus not capable of waiver – even if that waiver is express and undisputed.

Background

In In re Galaz, the debtor had been a co-owner with her husband of 50% of Artist Rights Foundation, LLC (ARF), a company organized to collect royalties owed to a former funk band. After the couple divorced, the ex-husband allegedly transferred away the company’s rights to collect those royalties to a third party company called “Segundo Suenos” without obtaining the consent of his ex-wife (then a 25% owner of the company, with no voting or management rights) or of their partner, Julian Jackson (who held the remaining 50% interest and the associated management rights). The debtor (i.e., the ex-wife) then commenced an adversary proceeding in bankruptcy court against her ex-husband, his co-conspirator, and Segundo Suenos, asserting claims for breach of fiduciary duty and pursuant to sections 542, 544, and 548 of the Bankruptcy Code and pursuant to the Texas Uniform Fraudulent Transfer Act, alleging that her ex-husband fraudulently transferred her rights to the royalties away from their jointly-owned company. The defendants then commenced a third-party complaint against Julian, who, in turn, asserted counterclaims against the defendants.

Let’s recap: Lisa, Raul, and Julian own ARF. Lisa and Raul get divorced. Raul transfers a 25% interest in ARF to Lisa, but the voting rights are not included. Raul and Alfredo transfer ARF’s value to Segundo Suenos (without Julian’s or Lisa’s consent). Lisa files for bankruptcy and sues Raul, Alfredo, and Segundo Suenos. They, in turn, sue Julian. Julian sues them back. All of this takes place in Lisa’s bankruptcy case.

After considering all of these claims, the bankruptcy court concluded that the transfer from ARF to Segundo Suenos constituted a fraudulent transfer under the Texas Uniform Fraudulent Transfer Act and entered a final judgment awarding the debtor damages. Raul and Segundo Suenos appealed to the district court, which affirmed. They then appealed to the Fifth Circuit, alleging, among other defenses, that the bankruptcy court lacked constitutional power to enter final judgment on the various claims against them (including, but not limited to, Lisa’s claims), in light of Stern v. Marshall.

Stern, at first glance, was not on point. The claims at issue were non-core “related to” claims instead of “core” claims (and were, therefore, not “Stern claims”). The district court, however, had affirmed the bankruptcy court’s final judgment because it concluded that the defendants had impliedly consented to entry of a final judgment in the bankruptcy same. Stern, then, was relevant insofar as certain courts (including the Fifth Circuit) have held that certain infirmities in a bankruptcy court’s ability to finally adjudicate a matter before it (whether they be core “Stern claims” or simply non-core claims) are not waiveable by the parties, even with their express consent to same.

Analysis

On appeal, the Fifth Circuit held that “the district court’s consent rationale” was inconsistent with circuit precedent stemming from the Fifth Circuit’s earlier Frazin and BP RE decisions, which (relying on the Sixth Circuit’s Waldman decision) held that “according to Stern, the parties’ express or implied consent cannot cure the constitutional deficiency that results from circumventing, or diminishing, the Article III structural protections for the federal judiciary.” The Fifth Circuit went on to note that the Supreme Court in Executive Benefits v. Arkison had dodged the issue of whether consent can cure these constitutional infirmities, but noted that the Court had granted cert in Sharif to resolve that issue. Nonetheless, pending resolution of that issue, the Fifth Circuit stated that until “the Supreme Court decides [that issue], we are bound by controlling circuit precedent.”*

The Fifth Circuit was then left with the question of how to deal with the case before it. Reverse? Dismiss? Remand? Showing great practicality, the Fifth Circuit stated that “[t]he failure of the consent rationale does not vitiate the lower courts’ work altogether, however.” Noting that even though the Supreme Court hadn’t settled the consent issue in Executive Benefits, it had addressed the statutory gap question in holding that where bankruptcy courts lack final adjudicatory authority, they may still issue proposed findings of fact and conclusions of law for review by the district court. Accordingly, the Fifth Circuit elegantly remanded the matter back to the district court for “de novo review of the bankruptcy court’s decision as recommended findings and conclusions.” Although we won’t weigh in on the merits of the actions in Galaz, we’d be surprised to see a vastly different outcome in that case in the end, notwithstanding the confusion and inefficiencies that Stern and its progeny may have generated.

Now that the circuit courts have gotten everyone up to speed, it’s on to the main event – Sharif.

 

*It should be noted that the bankruptcy court and the district court issued their opinions before the Fifth Circuit weighed in on the issues described herein, and therefore had not disregarded binding precedent in issuing their original decisions.