On December 4, 2012, the United States Court of Appeals for the Ninth Circuit decided Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency),1 which held that only an Article III court (such as a federal district court), but not a bankruptcy court, can enter a final judgment in a fraudulent transfer action against a defendant that has not filed a claim against the bankruptcy estate, but that the defendant’s right to an Article III court may be waived. The Court also held that despite the bankruptcy court’s lack of constitutional authority to make a final determination in a fraudulent transfer action, the bankruptcy court does have the statutory authority to issue proposed findings of fact and conclusions of law for consideration by the district court.
Until recently, the question of whether a bankruptcy judge could enter a final judgment depended on whether the matter was a “core proceeding” under 28 USC § 157. By definition, proceedings to determine, avoid, or recover fraudulent transfers are “core proceedings.” Id. § 157(b)(2)(H). Under the statute, a bankruptcy judge can hear and determine all “core proceedings,” subject only to appellate review. Id. § 157(b)(1). With respect to non-core matters, a bankruptcy judge may only “submit proposed findings of fact and conclusions of law to the district court.” Id. § 157(c)(1).
Some of the powers granted to bankruptcy judges under Section 157, however, have been held to be unconstitutional. Article III, Section 1 of the United States Constitution provides that “Judges . . . shall hold their Offices during good Behaviour, and shall . . . receive for their Services a Compensation, which shall not be diminished during their Continuance in Office.” Because bankruptcy judges do not have lifetime tenures or salary protections, they cannot decide matters reserved for Article III judges.
The Supreme Court, in a series of cases over many years, has continually narrowed the constitutional authority of bankruptcy judges. In Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), the Court held that a bankruptcy judge violated Article III by deciding a state law claim over the defendant’s objections. A plurality of the Supreme Court held that there were only three exceptions to the rule of Article III adjudication: territorial courts, military tribunals, and cases involving “public” as opposed to “private” rights. Id. at 67. The Court stated, in dicta, that proceedings “at the core of the federal bankruptcy power” may be “public rights.” Id. at 71.
In response to Northern Pipeline, Congress created the statutory core/non-core distinction. Citing the language in Northern Pipeline, the Ninth Circuit then concluded that all matters statutorily defined as “core” are “public rights that need not be decided by Article III judges.” In re Mankin, 823 F.2d 1296, 1308 (9th Cir. 1987).
The Supreme Court again addressed the issue of a bankruptcy court’s powers in Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989). There, the Court determined that a defendant has a Seventh Amendment right to a jury trial when sued by a bankruptcy trustee to recover a fraudulent transfer, so long as the defendant has not filed an affirmative claim against the estate. In Granfinanciera, the Court held that such an action was more accurately defined as a private rather than a public right. Then, in Stern v. Marshall, 131 S. Ct. 2594 (2011), the Court held that a state-law counterclaim filed by a bankruptcy petitioner against a claimant was not a matter of “public right” that could be decided by a bankruptcy judge.
Interpreting Northern Pipeline, Granfinanciera, and Stern, the Ninth Circuit held that the only logical conclusion that can be drawn from this precedent is that the bankruptcy judge does not have the power, under Article III, to decide a fraudulent transfer action against a defendant that has not filed a claim in the bankruptcy case and that, accordingly, Mankin is no longer good law.
The notion of a “core” matter that nonetheless may not be finally determined by the bankruptcy court creates a statutory ambiguity. If a bankruptcy court may hear and decide core matters, and may hear and make recommendations to the district court about non-core matters, what can they do with core matters that they do not have the power under Article III to decide? The Seventh Circuit has implied in dicta that bankruptcy courts have no power to hear such matters because they do not fall within the statutory framework. See Oritz v. Aurora Health Care, Inc., 665 F.3d 906, 915 (7th Cir. 2011). The Ninth Circuit disagrees, holding that bankruptcy courts should treat such cases as if they are non-core, because that is consistent with “the Stern Court’s tacit approval of bankruptcy courts’ continuing to hear and make recommendations about statutory core proceedings in which entry of final judgment by a non-Article III judge would be unconstitutional.” In re Bellingham, at 26.
The decision in Bellingham, however, did not change the result in that case. That is because, the court concluded, a defendant may consent to a bankruptcy judge deciding a non-core matter by not objecting. The defendant in Bellingham had filed a motion to withdraw the bankruptcy reference, but then asked the district court to stay its consideration of the motion to give the bankruptcy court the opportunity to adjudicate the trustee’s summary judgment motion. Thus, the court found that the defendant had waived its right to an Article III tribunal. Id. at 29.
In the eighteen months since Stern was decided, federal courts at all levels have struggled to determine the extent of the bankruptcy court’s power to adjudicate various nominally “core” matters, including preferences, fraudulent transfers, and assorted state law tort and contract claims. And while there is probably at least one decision to support every reasonable view, the emerging consensus seems to be consistent with Bellingham’s conclusion that bankruptcy courts cannot make final determinations on fraudulent transfer claims against non-claimant defendants, but that they are statutorily empowered to hear such matters and propose findings of fact and conclusions of law for the district court’s consideration.
Still, many questions raised by Stern remain without the benefit of any emerging view or consensus. For example, Stern clearly suggests that there may be circumstances under which an avoidance defendant who has filed a claim against the estate may nevertheless be entitled to a trial before an Article III court. The Ninth Circuit in Bellingham had no occasion to address this because the defendant in that case was not a claimant, but it is hard to see how that question alone will not cause the surge of post-Stern Article III jurisprudence to continue unabated pending further clarification from the Supreme Court.
Given the continued uncertainty of the Constitutional powers of the bankruptcy courts, defendants should carefully consider the risks and benefits of objecting early to the bankruptcy court’s jurisdiction rather than risk waiver.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:Wilamowsky-Steven
1 Exec. Benefits Ins. Agency v. Arkison (In re Bellingham Ins. Agency), No. 11-35162 (9th Cir. Dec. 4, 2012).
This article was originally published by Bingham McCutchen LLP.