Co-authored by Kyle J. Ortiz and Doron P. Kenter.
As we noted in our Stern anniversary post, despite the huge volume of cases citing Stern, and partially due to that volume, decisions adding anything new to the discussion are becoming a rare event.  The few cases that are saying something new or intriguing generally warrant a post of their own.  Going forward, instead of our typical digest format, the Stern Files will highlight specific cases that are either novel (such as our recent Kimball Hill post), significant, (such as our recent post on the Ninth Circuit’s Bellingham decision), or notably wacky (our recent post on Leo v. Hunter).  Although the Stern Files will be focused on a more nuanced analysis of the most significant cases, those looking for a comprehensive review should continue to look to our continually updated Stern Search Tool, through which decisions citing Stern can be sorted by circuit, jurisdiction, topic, and judge.
The Stern Files (Seventh Edition):
Waldman v. Stone, 698 F.3d 910 (6th Cir. 2012)
Background:  Chapter 11 debtor brought an adversary proceeding in the bankruptcy court against his principal creditor.  The bankruptcy court determined that the creditor had obtained essentially all of the debtor’s assets through fraud, ordered the debts discharged and awarded the debtor damages.  The district court affirmed and the creditor appealed to the Sixth Circuit, challenging the bankruptcy court’s constitutional authority to enter judgment regarding his claims.
Stern Impact:  Before addressing the limits of the bankruptcy court’s constitutional authority, the Sixth Circuit considered whether the creditor had waived his right to have the matter adjudicated by an Article III judge by failing to raise any objection to the bankruptcy court’s authority prior to the appeal.  The Sixth Circuit held that the right to Article III adjudication could not be waived because an objection based on a bankruptcy court’s constitutional authority (or lack thereof) “implicates not only [the creditor’s] personal rights, but also the structural principle [advanced by Article III] that is not his to waive.”
Having determined that the right to Article III adjudication could not be waived, the Sixth Circuit turned to the question of whether the matters before the bankruptcy court necessitated adjudication by an Article III court.  The Sixth Circuit stated that such authority hinged on whether the creditor’s “claims involve ‘public rights’” derived from a federal statutory scheme.
The Sixth Circuit held that disallowance of the creditor’s claims derived from a federal statutory scheme because they “were part and parcel of the claims-allowance process in bankruptcy” and thus, “the bankruptcy court was authorized to enter final judgment as to [the disallowance] claims.”  The Sixth Circuit held, however, that the entry by the bankruptcy court of a final judgment on the debtor’s affirmative damages claims arising from the alleged fraud violated Article III because the debtor’s “affirmative claims required him to prove facts beyond those necessary to his disallowance claims.”
The Sixth Circuit then addressed the practical question of how to remedy the bankruptcy court’s violation of its constitutional authority with regard to the damages claim and ultimately decided that it would “direct the bankruptcy court to convert its final judgment as to [the debtor’s] affirmative claims into proposed findings of fact and conclusions of law, which the district court would then review de novo.”
Murphy v. Felice (In re Felice), No. 08-01355-FJB, 2012 Bankr. LEXIS 4700 (Bankr. D. Mass. Oct. 5, 2012)
Background: A chapter 7 trustee brought an action against the debtor to establish the bankruptcy estate’s interest in a family trust, which the debtor had asserted was protected by a spendthrift clause and therefore was not part of the estate.  After stating that a proceeding to determine whether section 541 of the Bankruptcy Code brings an asset into the bankruptcy estate is a core proceeding, the court noted that, after Stern, it must still decide whether the Constitution allows a bankruptcy court to render a final judgment on such an action.
Stern Impact:  The court noted that, in Stern the Supreme Court acknowledged that the “public rights” exception might allow a non-Article III court to issue a final decision on a dispute between two private parties if the issue arose from a federal regulatory scheme (such as the Bankruptcy Code).  The court stated, however, that the “extent [to which] the ‘public rights’ doctrine reaches into the bankruptcy system – if it does at all – remains undefined.”  The court noted that many courts have adopted a broad interpretation of Stern referred to as the “Two-Prong Test,” stemming from Stern’s statement that “the question is whether the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” If either prong is met, the bankruptcy court retains constitutional authority to enter a final judgment, whereas if neither prong is met, the bankruptcy court lacks such authority.
Under even this broad “Two-Prong Test” the court held that it had constitutional authority to enter judgment over the claim in question because “an action under section 541 to determine whether an interest of the debtor is property of the estate stems from the bankruptcy, affects only the debtor’s property interest, and does not augment the estate.”
In dicta the court (relying heavily on Judge Hughes’ Teleservices decision) speculated that part of the concern with bankruptcy judges “running afoul of the Constitution” and the protections of Article III stems from Fifth Amendment concerns of “depriving a party of liberty or property without due process of law.”  The court stated that this concern is reflected in the “binary distinction” between claims seeking to “augment the estate” and those merely seeking a “pro rata share of the bankruptcy res.”  The court stated that actions that seek to augment the estate implicate Fifth Amendment due process rights because a private party may be compelled “to part with money or property.”
White v. Kubotek, No. 11-11828-NMG, 2012 U.S. Dist. LEXIS 142247 (D. Mass. Oct. 2, 2012)
Background:  A creditor brought a fraudulent conveyance action in state court against the purchaser of the debtor’s assets in chapter 11. The creditor had previously filed an unrelenting series of motions in the bankruptcy court seeking to have the sale order vacated.  After denying the creditor’s most recent motion, the bankruptcy court had enjoined the creditor from filing any “further papers, pleading or documents challenging the Sale Order.”  Thus, the creditor brought the action in state court against the debtor’s successor corporation.  The successor corporation removed the case to the bankruptcy court, which summarily dismissed the case.  The creditor then filed a motion for reconsideration, which was also denied.  Following Stern, the creditor appealed to the district court, challenging the denial of his motion for reconsideration and asserting that the bankruptcy court lacked “statutory authority because the proceeding no longer qualifie[d] as ‘core.’”
Stern Impact:  The district court stated that Stern stressed that core proceedings are those arising in a bankruptcy proceeding or under the Bankruptcy Code.  Thus, because the fraudulent transfer claim came into existence due to a sale commenced under the bankruptcy court’s oversight and was approved by the bankruptcy court; the claim was a core claim.  The court similarly held that the bankruptcy court had authority to enter a final judgment because the matter fell within the public rights exception because it would not exist outside the bankruptcy proceedings.
Lehman Brothers Holdings Inc. v. JPMorgan Chase Bank, N.A. (In re Lehman Brothers Holdings Inc.)480 B.R. 179 (S.D.N.Y. 2012)
Background: Debtor brought an adversary proceeding against creditor alleging common law damages claims, fraudulent transfer claims, and various other claims.  Creditor sought to withdrawal the reference.
Stern ImpactThe district court stated that its determination of the withdrawal motion would be guided by the Second Circuit’s Orion factors and Stern’s impact on those factors.  The Court stated that prior to Stern, the primary Orion factor was whether the claims in question were core or noncore, but that following Stern, the principle factor was now “whether the bankruptcy court has constitutional authority to enter a final judgment on the claims at issue.”
The court determined that the bankruptcy court did not have constitutional authority to enter a final judgment on at least a majority of the claims in the adversary proceeding because those claims could have been brought independent of the bankruptcy proceeding and were thus based on “private rights,” rather than “public rights.”
Despite the fact that the district court determined that the bankruptcy court could not finally adjudicate the claims, the district court applied the remaining Orion factors and denied the withdrawal motion because the bankruptcy court was already “fully immersed in the issues central to [the] litigation,” and it was clear that withdrawal would only cause further delay.  Although the court denied the withdrawal motion for the time being, it did note that if the matter ultimately proceeds to trial, it would “likely need to withdraw the entire reference at that time,” in light of the bankruptcy court’s lack of final authority over the claims.
TP, Inc. v. Bank of America, N.A. (In re TP, Inc.), 479 B.R. 373 (Bankr. E.D. N.C. 2012)
Background:  The debtor brought an adversary proceeding asserting certain counterclaims against a lender.  The lender moved to dismiss the proceeding or in the alternative to stay the proceeding based upon arbitration provisions in the loan documents because the debtor’s counterclaims were covered by the arbitration provisions and were mostly non-core claims.  In determining whether to refer the matter to arbitration, the court held that in light of Stern, once claims are determined to be “statutorily core,” they must then be subject to a second layer of review to determine whether they are “constitutionally core” (i.e., whether the bankruptcy court has constitutional authority over the matters).
Stern Impact:  The court noted that “the ruling in Stern does not prohibit the estate from bringing core counterclaims based in state law so long as the counterclaim would be fully resolved in the claims resolution process.  Accordingly, the court looked to the Stern two-prong test that asks “whether the action at issue stems from the bankruptcy itself,” or if “the issue would ‘necessarily’ be resolved in the claims allowance process.”  If either prong is met then the bankruptcy court retains the authority to enter a final judgment.  The court then reviewed each of the counterclaims – referring most claims to arbitration, but keeping counterclaims for rescission, fraudulent inducement, and equitable subordination because each of these met the aforementioned test for final judgment in the bankruptcy court.
Rosenberg v. Bookstein,479 B.R. 584 (D. Nev. 2012)  
Background: A chapter 7 trustee asserted various fraudulent transfer claims against several defendants.  The defendants collectively filed a motion seeking to withdraw the reference, citing a lack of jurisdiction due to the defendants’ request for a jury trial and the Supreme Court’s ruling in Stern.
Stern Impact: The district court held that, following Stern, bankruptcy judges lack constitutional authority to enter final judgments on fraudulent conveyance claims because, in analogizing the state-law counterclaim in Stern with the fraudulent conveyance claim in Granfianciera, the Supreme Court had held that neither type of claim fellwithin the public rights exceptions.  Consequently, both types of claims were beyond the bankruptcy court’s final constitutional authority.  The court noted that bankruptcy judges should enter proposed findings of fact and conclusions of law in such cases because it both preserves judicial resources and “leverages the competency of bankruptcy judges for use by the district court.”  Finally, the court agreed with the defendants that jury trials on fraudulent transfer claims must be held in the district court.  However, the court held that the mere request for a jury trial does not automatically result in withdrawal of the reference because it is not certain the case will ever proceed to trial.  Moreover, allowing immediate withdrawal could encourage litigants to use jury trial requests as a “litigation tactic” to avoid bankruptcy court.
United States v. Bond, No. 11-5608 (BMC), 2012 U.S. Dist. LEXIS 132598 (E.D.N.Y  Sept. 17, 2012)
Background:  The IRS filed a proof of claim against the debtor for administrative tax expenses, penalties for failure to pay taxes, and interest on the outstanding payments.  The chapter 11 trustee filed a motion to disallow the IRS’s claims and sought to recover a tax refund, alleging an overpayment to the IRS.  The bankruptcy court issued a final order allowing the trustee to recover the overpayment and disallowing the IRS’s claims. The IRS appealed from the bankruptcy court’s final order.
Stern Impact:  Before dealing with the issues on appeal, the district court first noted that the applicable standard of review depended on the characterization of the claims.  Prior to Stern, once a proceeding was characterized as a core proceeding, the applicable standard of review was straight-forward: questions of law were reviewed de novo, findings of fact would not be set aside unless clearly erroneous, and discretionary matters were reviewed for abuse of discretion. However, after Stern, the fact that a matter was statutorily defined as a core proceeding no longer determined the particular standard of review.  The court, however, avoided the difficult determination of which categories of core proceedings should continue to be reviewed under the pre-Stern standardand instead held that because the dispute regarding the tax liability dealt with “public rights” (due in part to the fact that the present case was, a “suit between the United States Government and a party subject to the Government’s authority), the claim was subject to final adjudication by an Article I court and that, therefore, the pre-Stern standard of review for core proceedings continues to apply to this matter.
Neilson v. Monterey County Bank (In re Cedar Funding, Inc.), No. 12-00643-RMW, 2012 U.S. Dist. LEXIS 113903 (N.D. Cal. Aug. 13, 2012)
Background:  A creditor brought a motion to withdraw the reference in a proceeding to determine the validity of a deed transfer.
Stern Impact:  The court concluded that a claim regarding the validity of a deed transfer was more akin to a declaratory action seeking a determination as to what was property of the estate than to a fraudulent transfer action, which is brought to augment the estate.  The court thus concluded that the case should remain with the bankruptcy court through trial, because the proceeding was “but one in a large, complex bankruptcy.” The court also noted that “[a]lthough the bankruptcy court’s proposed findings would be subject to de novo review . . . upon a party’s specific objection, it is not clear that any delay and costs associated with that process would outweigh the efficiency gains from allowing the bankruptcy court to try the case in the first instance.”  The court also stated that leaving the case with the bankruptcy court would promote the uniform administration of bankruptcy proceedings because the bankruptcy judge enjoys greater expertise in the areas of law in question.   The court also noted in dicta that a motion to withdraw the reference in a non-core proceeding should be asserted at the beginning of the proceeding, because 28 U.S.C. 157(d) provides for withdrawal on “timely motion” by any party.