The Stern Files (second edition)

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Contributed by Kyle J. Ortiz

In our first edition of the Stern Files we summarized decisions applying the Supreme Court’s ruling in Stern v. Marshall, No. 10-179, 2011 WL 2472792 (U.S. June 23, 2011).  As our second edition demonstrates, the courts continue to grapple with the boundaries of permissible bankruptcy court jurisdiction after Stern.  Judging by the motion practice we’ve seen, this trend shows no sign of slowing, so be sure to check back with us for future editions of the Stern Files.

As a reminder, we’re focusing only on cases that directly relate to the jurisdiction of the bankruptcy courts, not decisions that merely cite Stern.

Stern Files for the period August 2, 2011 through August 31, 2011:

In re Muhs, No. 10-01008, 2011 WL 3421546 (Bankr. S.D. Tex. Aug. 2, 2011)  Background:  Creditor filed an adversary proceeding challenging the dischargeability of a debt.Stern Impact:  The court held that the determination of whether a debtor meets the conditions for the statutorily established right to discharge is integral to the bankruptcy scheme and within the bankruptcy court’s jurisdiction.Additionally, in dictum that appears to be emerging as standard language in cases discussing Stern out of the Bankruptcy Court for the Southern District of Texas, the court stated that the “broader applicability of the [Supreme] Court’s decision remains unclear.”  In particular, the court notes that Stern has left unclear whether the adjudication of a fraudulent transfer claim against a creditor who has filed a proof of claim falls within the public rights exception and that the bankruptcy court’s authority over matters involving state law causes of action is particularly questionable.  The court also notes that, after Stern, “at least two overlapping classes of claims fall within the [bankruptcy] court’s constitutional authority: (1) matters invoking only the court’s in remjurisdiction over the bankruptcy estate and (2) disputes over rights created by the Bankruptcy Code as an integral part of the public bankruptcy scheme.”

See also In re Ritz, No 10-03156, 2011 WL 3439246 (Bankr. S.D. Tex. Aug. 4, 2011)Ritz follows Muhs verbatim (with regard to jurisdiction and Stern) and finds that determination of a debtor’s right to a discharge is part of a public bankruptcy scheme.

In re Schmidt, No. 11-6028, 2011 WL 3300693 (8thCir. B.A.P. Aug. 3, 2011)  Background:  Bank brought replevin actions against debtors in state court.  After filing for chapter 11, the debtors removed the replevin actions to the bankruptcy court.  Bank filed motions to remand based on the mandatory abstention provision of 28 U.S.C. § 1334 which states that “[u]pon a timely motion of a party in a proceeding based upon a State law claim or State law cause of action, related to a case under title 11 but not arising under title 11 . . . the district court shall abstain from hearing such proceedings if an action is commenced, and can be timely adjudicated, in a State forum of appropriate jurisdiction.”Stern Impact:  The bankruptcy court denied the bank’s motion to remand, holding that mandatory abstention did not apply because the replevin action was a core proceeding under “at least three of the sixteen types of core proceedings enumerated in 28 U.S.C. § 157(b)(2).”  The Bankruptcy Appellate Panel for the Eighth Circuit reversed, holding that the Supreme Court in Stern “rejected the notion that § 157 embodies a category of matters that are core.”  Rather, the court held that Stern changed the test for whether a matter is core.  After Stern, “core proceedings are those that arise in a bankruptcy or under title 11.”  Applying this test, the court held that the replevin actions did not “arise under or arise in the debtors’ bankruptcy case” and, thus, mandatory abstention should apply.  The B.A.P. remanded to the bankruptcy court for further findings on whether the bankruptcy court is required to abstain under 28 U.S.C. § 1334(c)(2) and whether the matter could be timely adjudicated in state court.
In re Innovative Comm. Corp., No. 08-3004, 2011 Bankr. LEXIS 3040 (Bankr. D.V.I. Aug. 5, 2011)  Background:  Chapter 11 trustee brought an adversary proceeding seeking to recover alleged prepetition fraudulent conveyances and unauthorized postpetition transfers.  The defendants responded by filing a motion to dismiss based upon Stern.Stern Impact:  The court held that it had jurisdiction over the fraudulent transfer actions brought under sections 548 and 549 of the Bankruptcy Code because those causes of action are created by the bankruptcy laws. The court stated, however, that dictum in the Sternopinion leaves uncertainty with respect to its jurisdiction over fraudulent conveyance actions brought pursuant to state law and section 544(b) of the Bankruptcy Code (providing the trustee with power to avoid transfers that are voidable under applicable law).Thus, the court held that it could make final judgments on the actions stemming from sections 549 and 548 of the Bankruptcy Code, but it would only make a report and recommendation to the district court for the actions stemming from section 544(b).  It also said that if the district court reads Stern more broadly, then its final judgment on the 549 and 548 claims would instead constitute a report and recommendation to the district court.
In re Sitka Enters., No. 10-1847, 2011 U.S. Dist. LEXIS 90243 (D.P.R. Aug. 12, 2011)  Background:  Chapter 7 trustee sought to void allegedly fraudulent transfers of property of the debtor’s estate under sections 548 and 549 of the Bankruptcy Code.Stern Impact:  The court found that Stern “has its roots in Granfinanciera” and interpreted Granfinanciera as “rejecting the . . . argument that a fraudulent conveyance action by a bankruptcy trustee fell with the public rights exception.”  It held that because a trustee’s action to recover a fraudulent conveyance involves private rather than public rights, the fraudulent conveyance action “cannot be adjudicated by the Bankruptcy Court since it lacks constitutional authority to do so under the restrictions placed by Article III.”
In re Jordan River Resources, Inc., No. 09-80301, 2011 WL 3625096 (Bankr. W.D. Mich. Aug. 16, 2011) Background:  Liquidating Trust objected to preferred interest asserted by claimant.Stern Impact:  The court found it had jurisdiction to determine whether claimant held interests in estate res, because the question “stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.”  It distinguished the question from a “proceeding to augment the estate,” which it stated was “presumptively within the purview of a life-tenured district judge with salary protections under Article III of the U.S. Constitution.”
In re Terri Gay Hudson, No. 10-80005, 2011 WL 3583278 (Bankr. W.D. Mich. Aug. 16, 2011) Background:  Chapter 7 trustee sought to avoid a bank’s mortgage on real property because the property description in the mortgage contained the wrong legal description.Stern Impact:  The court held that it had power to determine validity, extent and priority of lien on debtor property under section 544 of the Bankruptcy Code even though such a determination requires review of state law issues.  The court stated that, outside the counterclaims addressed in Stern, a “bankruptcy judge remains empowered to enter final orders in all core proceedings.”  As a fall-back, the court noted that, should its order be appealed and the district court determine on appeal that the bankruptcy court lacked jurisdiction to enter a final order, the decision would constitute a report and recommendation to the district court.
In re Teleservices Group, Inc., No. 07-80037, 2011 WL 3610050 (Bankr. W.D. Mich. Aug. 17, 2011) Background:  Bank filed a motion to amend the bankruptcy court’s pretrial order designating a fraudulent transfer claim as a matter on which it could enter a final determination upon.Stern Impact:  In considering whether it had authority to enter final judgment on the fraudulent conveyance action, the bankruptcy court found the reasoning of the Stern opinion indicated that it could no longer rely on the core/non-core distinction to determine if an exercise of jurisdiction was constitutional.  It also found that Stern offered no guidance for the problem, but that it had to determine whether it had authority to enter final orders with respect to “any issue arising in this case, no matter how ‘core’ it might be” before it could decide the issue.It found support in Murray’s Lesseefor using a Fifth Amendment distinction to determine which determinations lay within its power.  It held that actions that deprive a litigant of property require an Article III judge to satisfy the due process protections of the Fifth Amendment, but actions that are exercises of Congressional power to collect and distribute a bankruptcy estate do not alter non-debtor property rights, and may therefore be decided or implemented by the authority of Congress’ choosing.  Examples of matters the court found subject to its final determination include 363 sales, incurring debt, assuming/rejecting contracts, distributing proceeds to competing lien creditors, approving a settlement, making determinations on the stay and discharge injunction, and making decisions in the claims adjudication process.Because the fraudulent conveyance action sought a money judgment, the bankruptcy court, concluded that only an Article III court could enter final judgment.  Having already held hearings and made determinations on major issues, the bankruptcy court stated that it would issue a report and recommendation to the district court.
In re Bigler LP, No. 10-03304, 2011 WL 3665007 (Bankr. S.D. Tex. Aug. 19, 2011) Background:  Secured creditors filed an adversary proceeding requesting a declaratory judgment regarding priority of their liens on the debtor’s property.Stern Impact:  Bankruptcy court held that it had jurisdiction to resolve the dispute under the public rights exception because the determination of lien priority involves “the exercise of the bankruptcy court’s in remjurisdiction over the estate.”Additionally, the court again recited its standard dictum, regarding Stern, discussed above in the entry for the Muhs decision.
In re Palazzola, No. 10-3254, 2011 WL 3667624 (Bankr. N.D. Ohio Aug. 22, 2011)  Background:  Debtors brought an adversary proceeding against the City of Toledo, alleging among other things, violation of constitutional rights under 42 U.S.C. § 1983.  Toledo moved to dismiss.Stern Impact:  The court held that the section 1983 claim was “in essence, a personal injury tort claim,” and, under Stern, was beyond the court’s jurisdiction because tort claims have their roots in common law, do not arise in or as a result of the bankruptcy, and do not involve a public right  The bankruptcy court found that it did have jurisdiction to hear a separate count alleging that defendant had violated the automatic stay by applying postpetition payments to satisfy a prepetition debt.
In re Olde Prairie Block Owner, LLC, No. 10-B-22668, 2011 WL 3792406 (Bankr. N.D. Ill. Aug. 25, 2011)  Background:  Creditor filed a proof of claim asserting a secured claim in connection with a loan contract and the debtor filed five counterclaims, alleging: (1) economic duress; (2) tortious interference; (3) breach of contractual duty of good faith; (4) breach of an extracontractual fiduciary duty; and (5) negligence.Stern Impact:  Bankruptcy court held that it had jurisdiction over all the claims because two of the five counterclaims were “necessarily resolved in order to rule on the creditor’s claim” and “the parties had consented to final adjudication by a Bankruptcy Judge” of all the claims.  The court stated that counterclaims that are governed by Stern must under the Constitution be treated as non-core proceedings so they are subject to the consent procedures under 28 U.S.C. § 157(c)(2) and bankruptcy judges may enter final judgment if the parties consent.
In re Washington Mutual, Inc., No. 08-12229, slip op. (Bankr. D. Del. Sept. 13, 2011)[1]  Background:  Debtors sought confirmation of chapter 11 plan incorporating a Global Settlement Agreement (“GSA”) that resolved disputes between former thrift holding company, acquiror of failed thrift, and FDIC.  Objectors asserted that, following Stern, the court could not enter a final ruling on the plan because it would settle state law claims through the GSA.Stern Impact:  Judge Walrath disagreed with the equity holders and, in a thorough discussion of the limits of Stern v. Marshall, concluded that there was no constitutional impediment to bankruptcy court determination of the fairness of the GSA in connection with consideration of the plan of reorganization.  Judge Walrath stated there is a fundamental difference between approval of a settlement of claims and ruling on the merits of such claims because consideration of a settlement does not require a final adjudication on the merits of the claims.  Additionally, Judge Walrath concluded that there is a “firmly established historical practice” of bankruptcy courts exercising broad discretion in approving settlements and noted that the concurring opinion in Stern suggested non-article III judges retain authority to make determinations where there is a historical practice of them doing so.  Finally, Judge Walrath, noting that the claims resolved by the GSA concerned ownership of specific property, stated that “[i]t is without question that bankruptcy courts have exclusive jurisdiction over property of the estate.”