The Stern Files

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Contributed by Kyle J. Ortiz

As evidenced by the triumph of Northern Pipeline Construction Co. v. Marathon Pipe Line Co., in the Weil Bankruptcy Blog’s sweet sixteen, the jurisdiction of the bankruptcy courts is foremost on the minds of many practitioners.  So it should come as no surprise that the bankruptcy bar is abuzz following the Supreme Court’s recent decision in Stern v. Marshall, 564 U.S. 2 (2011), holding that bankruptcy courts lack the constitutional authority to enter final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor’s proof of claim.

As soon as the Stern opinion was released, the question on the minds of bankruptcy professionals everywhere was how would Stern affect the bankruptcy practice?  The answer to that question will be determined largely by how the lower courts interpret the Supreme Court’s ruling.

With that in mind, the Weil Bankruptcy Blog is introducing a new periodic series: the Stern Files.  We will publish intermittent updates identifying cases where Stern jurisdictional issues are raised and adjudicated.  We’re focusing only on cases that directly relate to the jurisdiction of the bankruptcy courts, not decisions that merely cite Stern.  Check back with the Weil Bankruptcy Blog often for updates.

Stern Files through August 3, 2011:

In re Boricich, No. 08 A 00728, 2011 WL 2600692 (Bankr. N.D. Ill. Jun. 29, 2011) Background:  A former business partner of a chapter 7 debtor objected to discharge of his claim against the debtor under section 523(a)(4) of the Bankruptcy Code because the debtor allegedly had committed fraud while acting in a fiduciary capacity.Stern Impact:  The court found the debt was not dischargeable.  Although Seventh Circuit practice prior to Stern was for a bankruptcy judge to determine allowance of a claim after finding it non-dischargeable and enter judgment in favor of the creditor on account of such claims, the bankruptcy court questioned whether it had authority to follow this practice post-Stern.  Accordingly, it declined to enter a dollar judgment in favor of the creditor and limited its holding to a determination of the amount of debt found nondischargeable.Note:  The court reserved jurisdiction to entertain a motion to amend the judgment within 28 days supported by briefs discussing Sternand demonstrating that constitutional authority to enter such a money judgment exists.  Both parties subsequently briefed the issue and are awaiting decision by the court.
In re Gorilla Cos. LLC, 2011 U.S. Dist. LEXIS 71427 (D. Ariz. Jul. 1, 2011) Background:  A debtor asserted counterclaims against a party that filed proofs of claim.  The bankruptcy court entered final judgment in favor of the debtor on its counterclaims, which were premised on breach of contract, breach of the covenant of good faith and fair dealing, fraud, negligent misrepresentation, and unjust enrichment.  Subsequently, the claimant sought leave to file a motion for rehearing in light of the jurisdictional issues raised by Stern.Stern Impact:The court ruled that the change in law resulting from Sternwas sufficient to approve the motion for rehearing.
In re Polaroid Corp., No. 10-4595, 2011 WL 2694316 (Bankr. D. Minn. Jul. 7, 2011) Background:  The chapter 7 trustee asserted a counterclaim for breach of contract under a brand license agreement seeking a money judgment against a creditor that had filed a proof of claim against the estate.Stern Impact:  The court discussed Stern at length and concluded that, “absent consent, a presiding bankruptcy judge will have to suggest a rationale and a possible outcome to the district court . . . [or] with consent, a bankruptcy judge [can enter] a judgment.”The court stated that in the instant case the status of consent was uncertain because the parties had not been clear in their pleadings.  As a result, the court ordered the parties to file “express written statements as to whether their clients consent to entry of a final judgment . . . [by] a bankruptcy judge.” Although the trustee consented, the creditor did not.  Moreover, the creditor expressed its view that consent of the parties may be “irrelevant” under Stern, and any final judgment would suffer the same constitutional infirmities regardless of consent.  The creditor also stated that it hoped that “the Judicial Conference of the United States will shortly recommend a revised standing order to be adopted by all federal courts.”
In re BearingPoint, Inc., No. 09-10691 (REG), 2011 WL 2709295 (Bankr. S.D.N.Y. Jul. 11, 2011) Background:  The trustee of  a liquidating trust established under BearingPoint’s confirmed chapter 11 plan moved for an order granting limited relief from certain provisions of the plan and confirmation order.  Judge Gerber issued a bench decision modifying the confirmed chapter 11 plan to grant the requested relief.Prior to the modification, all claims asserted against current and former officers and directors of BearingPoint were subject to the exclusive jurisdiction of the bankruptcy court, ostensibly because Judge Gerber’s institutional knowledge of the case, acquired during the bankruptcy proceedings, made him best suited to adjudicate any disputes arising out of the bankruptcy.Stern Impact:  Judge Gerber modified the chapter 11 plan so that such claims could be brought in state court.  Judge Gerber noted that, although the claims could be heard in his court, following Stern he would not be authorized to enter a final judgment.  Thus, to prevent the action from being “tied in procedural knots by motion practice . . . exploiting asserted or actual inabilities on [his]part . . . to issue findings and orders,” Judge Gerber granted the trustee’s motion to modify the exclusive jurisdiction requirement of the plan and confirmation order.
Turner v. First Community Credit Union, No. 10-03300, 2011 WL 2708907 (Bankr. S.D. Tex. Jul. 11, 2011) Background:  Without seeking relief from the automatic stay, a bank froze the accounts of a chapter 13 debtor and set off amounts owed by the debtor against such accounts.  The debtor sought damages from the bank for an alleged violation of the automatic stay.Stern Impact:  The court stated that it had jurisdiction to hear the case even though, like in Stern, the case was based on a counterclaim.  The court held that in Stern the dispute concerned a state law issue, whereas the case before the court in Turnerarose out of “violations of the automatic stay imposed by an express Bankruptcy Code provision.”  Thus, the court held that the dispute was a core proceeding arising under the Bankruptcy Code.The court went on to state alternatively that, even if Stern were to apply, the case at hand would fall under the “public rights” exception articulated in Stern.   The court declared that “[t]he Bankruptcy Code is a public scheme for restructuring debtor-creditor relations,” and thus core claims are protected under the public rights exception.  Because the dispute involved the automatic stay, a provision that the court stated “is one of the most important – if not the most important – features of the Bankruptcy Code,” the court held that the dispute involved a “public right” and, thus, the bankruptcy judge had constitutional authority to make a final judgment.Ultimately, the court held that the bank had violated the automatic stay, but that the debtor failed to prove any damages making this in the words of the court “a case of ‘no harm, no foul.’”
In re Graham, No. 11-01073 (SBB), 2011 WL 2694146 (Bankr. D. Colo. Jul. 11, 2011) Background:  A creditor brought an adversary proceeding to prevent the debtor from discharging a debt arising from a fight at a baseball game that led to the debtor pleading guilty to second degree assault and (after a lengthy civil litigation) entering into a settlement with the creditor.  The creditor alleged that the debt was nondischargeable under section 523(a)(6) of the Bankruptcy Code because it arose as a result of “willful and malicious injury.”  The debtor claimed he was acting in self defense.  Thus, the bankruptcy court had to decide whether under Colorado State law a guilty plea to second degree assault “has the consequence of waiving the affirmative defense of self-defense.”Stern Impact:  In a footnote, the court noted that the Supreme Court’s ruling in Stern may put into doubt its authority to rule on the affirmative defense issue because it emanates from an interpretation of Colorado civil tort law and criminal law.  The court stated, however, that it believed it could rule because the underlying state matter had been fully litigated and the court was dealing “only with the question of dischargeability.”
In re Mandel, No. 10-4099) 2011 WL 278415 (Bankr. E.D. Tex. Jul. 12, 2011) Background:  The debtors asserted a counterclaim for restitution against a creditor architect, claiming that they paid for an exclusive, copyrighted set of plans for a property and that the architect used those plans for another property.Stern Impact:  The court held, citing Stern, that it did not have the constitutional authority to decide the counterclaim absent the parties’ express consent.
In re Salander O’Reilly Galleries, No. 07-30005, 2011 WL 2837494 (Bankr. S.D.N.Y. Jul. 18, 2011) Background:  A party that had consigned, prepetition, a painting to a gallery filed a proof of claim for “consigned artwork” in the gallery’s chapter 11 case.  After confirmation of the gallery’s plan of liquidation and transfer of all its assets to a liquidating trust, the consignor sought relief to pursue arbitration pursuant to the terms of the consignment agreement on the issue of whether the painting constituted property of the gallery’s estate.  Judge Morris did not find cause to lift the stay and enforce the arbitration clause because “[t]he presumption of enforceability of arbitration clauses must yield to the policies of the Bankruptcy Code, where the matter to be arbitrated is substantively core.”Stern Impact:  Judge Morris concluded that the issue of whether the painting constituted property of the estate was at the “heart of whether [the consignor’s] claim [would] be allowed.”  Distinguishing Stern, Judge Morris stated that “Sternis replete with language emphasizing that the ruling should be limited to the unique circumstances of that case, and the ruling does not remove from the bankruptcy court its jurisdiction over matters directly related to the estate that can be finally decided in connection with restructuring debtor and creditor relations.”Judge Morris noted that in Stern, the bankruptcy court would have had to make a “determination . . . beyond what would have been required to determine whether to allow the claim,” but in the present case, it was clear that “the substance of [the] requested relief [would] have a dramatic effect on the resolution of [the consignor’s] proof of claim.”Judge Morris went on to discuss Stern’s treatment of Marathon, and Granfinanciera, concluding:

“Nowhere in Marathon, Granfinanciera, or Stern does the Supreme Court rule that the bankruptcy court may not rule with respect to state law when determining a proof of claim in the bankruptcy, or when deciding a matter directly and conclusively related to the bankruptcy.  As noted, Stern repeatedly emphasizes that it addresses only the constitutionality of the bankruptcy court making a final ruling on a state-law counterclaim that would not be finally resolved in the process of allowing or disallowing a proof of claim.”

The court held that, when the jurisdiction of the bankruptcy court is questioned, the resolution of a proof of claim is of foremost concern as it involves a request for payment from the estate.  Thus, Judge Morris concluded that “allowance of claims is indisputably the realm of the bankruptcy court,” and because “the bankruptcy court’s ruling will finally determine [the consignor’s] art claim and proof of claim, [the motion] . . . is within the jurisdiction of [the bankruptcy court].”

In re Roberts, No. A10-4097 (TLS), 2011 WL 3035268. (Bankr. D. Neb. Jul. 19, 2011) Background:  A chapter 7 debtor owned land subject to a deed of trust held by Nebraska Housing Corp. (“NHC”).  NHC obtained relief from the automatic stay to sell the property pursuant to its deed of trust despite competing demands by non-debtor parties to the property.  As a result, the chapter 7 trustee filed an interpleader action to quiet title among the parties claiming an interest in the land.  The court ruled that it lacked subject matter jurisdiction because the interpleader action was not a core proceeding.  The court reasoned that unlike in chapter 11 cases where an interpleader action could alter liabilities and affect the estate, the chapter 7 debtor had already received a discharge and thus the interpleader would have no effect on the bankruptcy estate.Stern Impact:  The court stated that the Supreme Court “has recently made clear that bankruptcy courts should refrain from impinging upon the exclusive jurisdiction of the Article III courts by entering judgments on state law claims involving non-debtor third parties.”  The court ordered the cased closed and the file transferred to the district court.
In re American Business Financial Services, Inc., No. 05-10203, 2011 WL 3240596 (Bankr. D. Del. Jul. 28, 2011) Background:  A chapter 7 trustee brought an adversary proceeding against two entities allegedly hired to act as agents of the bankruptcy estate.  The trustee asserted claims for fraudulent transfer under the Bankruptcy Code, fraudulent transfer under state law, breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, common law fraud, civil conspiracy, objections to and subordination of the estate’s agents claims, and declaratory relief.Stern Impact:  Discussing Stern in a brief paragraph on jurisdiction, Judge Walrath stated that the Supreme Court’s decision was a “narrow one,” focused “on ‘whether the action at issue stems from the bankruptcy itself.’”  The claims brought by the trustee in ABFS arose after ABFS filed bankruptcy and, according to the court, related “entirely to matters integral to the bankruptcy case.”  Judge Walrath reasoned that, “[i]f not for the bankruptcy, these claims would never exist” and concluded there was no constitutional impediment to adjudication of the claims in the bankruptcy court.  Judge Walrath cited the Southern District of New York’s recent Salander opinion (see above) to support the notion that Stern does not prohibit bankruptcy courts from ruling on a state law claim “when deciding a matter directly and conclusively related to the bankruptcy.”
Matrix IV, Inc. v. American Nat. Bank and Trust Co., No. 08-3917, 09-1321, 2011 WL 3211500 (7th Cir. Jul. 28, 2011) Background:  Matrix, a creditor, filed with the district court a complaint that included RICO and common law fraud claims against two non-debtor parties.  The non-debtor parties moved to dismiss, asserting issue and claim preclusion based on prior rulings against Matrix in the bankruptcy case.  The district court granted defendants’ motion to dismiss, finding that the doctrines of claim preclusion and issue preclusion barred the claims.  On appeal, the Seventh Circuit affirmed the dismissal, but on narrower grounds, holding only that issue preclusion applied.  The Seventh Circuit ruled on this narrow ground because application of the doctrine of claim preclusion to bankruptcy matters is the subject of a split in the circuits, with most courts holding that bankruptcy court adjudication of a core matter has preclusive effect with respect to later adjudication of a non-core matter that could have been asserted previously but was not.  One Seventh Circuit decision, however, came to the opposite conclusion.  Rather than resolve this split, the Seventh Circuit deferred it, reasoning that the Matrix action could be resolved without reaching the issue.Stern Impact:  The Matrix case does not directly implicate Stern, but in dicta the Seventh Circuit noted that the Supreme Court’s decision may make resolution of the circuit split more complicated.  Although it provided no other commentary on Stern, the Seventh Circuit appeared to suggest that courts will have to assess Stern’s conclusions on the constitutional limitations of bankruptcy court jurisdiction in determining the preclusive effect of their decisions on non-core matters.
Blixseth v. Blixseth, No. 10-00088, 2011 WL 3274042 (Bankr. Mont. Aug. 1, 2011) Background:  The chapter 7 trustee commenced an adversary proceeding against the debtor’s ex-husband for breach of fiduciary duty, constructive trust under California law, equitable subordination, and to avoid and recover, pursuant to the Bankruptcy Code, fraudulent transfers and preferential transfers under the former couple’s Marriage Settlement Agreement. The ex-husband sought dismissal of the adversary proceeding for lack of subject matter jurisdiction and for failure to state a claim upon which relief could be granted, arguing that the action was “barred on its face by the Rooker-Feldman doctrine [federal courts should not sit in appellate review of state courts], the California Superior Court’s continuing jurisdiction over the terms of the marital settlement agreement, res judicata, collateral estoppel, estoppel by contract, mutual releases and in pari delicto.”Stern Impact:  The court went through each of the ex-husband’s arguments denying each as a grounds for dismissal.  After making that analysis, however, the court considered sua sponte the impact of Stern and stated that, “although this Court has core jurisdiction over the equitable subordination and fraudulent and preferential transfer claims pursuant to its statutory authority, that authority may not be exercised unless it is also constitutional.”The court concluded that the fraudulent conveyance claims are common law claims attempting to augment the estate and neither stem from the bankruptcy nor are resolved by the claims allowance process.  As such, the court held that a fraudulent conveyance action is a private right that “must be adjudicated by an Article III court.”  The court granted the parties 14 days leave to move the district court to withdraw its reference, or it would “dismiss the fraudulent conveyance claims for lack of subject matter jurisdiction.” 
In re Okwonna-Felix, No. 10-31663, 2011 WL 3421561 (Bankr. S.D. Tex. Aug. 3, 2011) Background:  A chapter 13 debtor filed a motion for approval of compromise pursuant to Bankruptcy Rule 9019.  As part of the compromise, the debtor sought to exempt from the bankruptcy estate the proceeds of a lawsuit against the insurance company insuring his homestead.  The court held that, because the resolution of the motion was grounded entirely in federal bankruptcy law (specifically Bankruptcy Rule 9019), it had the constitutional authority to enter a final judgment.Stern Impact:  The court distinguished Stern by noting that the dispute in Stern concerned “purely state law issues,” whereas a settlement under Bankruptcy Rule 9019 involved interpretation of “an express bankruptcy provision.”  The court noted that state law has no equivalent to Bankruptcy Rule 9019, which gives bankruptcy courts broad discretion to approve settlements, and that factors considered in such a determination “have been developed entirely by the federal courts.”The bankruptcy court further noted that, even if Stern was applicable, it could still enter a final judgment by virtue of the “public rights” exception. The court reasoned that the right to exempt property touched on the exclusive jurisdiction of bankruptcy courts over a debtor’s property and the equitable distribution of that property and therefore was inextricably tied to the bankruptcy scheme,” and “involves the adjudication of rights created by the Bankruptcy Code,” thus falling within the public rights exception.