Supreme Court Decision May Enhance Federal Jurisdiction over Bankruptcy Sale Disputes

Journal Issue

Jul/Aug 2006

Column Name

Feature

Citation

ABI Journal, Vol. XXV, No. 6, p. 44, July/August 2006

Bankruptcy Code

1334

363

Topic Tags

Asset Sales

Venue/Jurisdiction

Journal HTML Content

The ability to sell assets free and clear of liens and other interests is a powerful
tool available to a debtor-in-possession (DIP) or trustee under the Bankruptcy
Code, allowing a bankruptcy estate and its creditors to benefit from the enhanced
value offered by a purchaser that receives assets free of historical taints.
Not all parties in interest necessarily benefit equally from a sale free and
clear, however. For example, tort claimants may lose successor-liability claims
otherwise available to them under state law, and account debtors may find their
ability to resist payment impaired if assets are sold in a manner that limits
setoff claims. Post-sale disputes between asset purchasers and other nondebtor
parties are fairly common and often are accompanied by disagreement as to the
proper forum in which they should be resolved, with purchasers typically preferring
to have issues resolved by the bankruptcy court that approved the sale and other
parties favoring the courts of the state whose law applies to the substance
of the dispute.
The bankruptcy and appellate courts have not been consistent in their resolution
of these jurisdictional issues. Some courts have held broadly that federal bankruptcy
jurisdiction does not encompass post-sale disputes not involving the debtor;
others have concluded that in particular circumstances, the bankruptcy courts
lack jurisdiction, and still others have held it appropriate for the bankruptcy
courts to resolve such disputes.
A recent Supreme Court decision may improve the chances that a purchaser of
assets from a debtor will have access to a federal forum to resolve a post-sale
dispute. In Grable & Sons Metal Products Inc. v. Darue Engineering &
Manufacturing,1 the Court held that a dispute about the effect
of a federal tax sale was within the federal-question jurisdiction of the federal
courts, even though the plaintiff's cause of action arose under state law. As
this article was written, Grable & Sons had not yet been applied
in a published bankruptcy decision, but much of the reasoning of the case could
be translated to the bankruptcy context.

Jurisdictional Confusion in Bankruptcy Sale Disputes
 When a purchaser of assets from a bankruptcy estate is faced with third parties
that it perceives to be recalcitrant—such as tort claimants who pursue
successor-liability claims in violation of the bankruptcy court's sale order—the
purchaser can have the dispute resolved in a federal forum if it falls within
the framework of 28 U.S.C. §1334(b). That section gives the federal district
courts jurisdiction over "all civil proceedings arising under title 11,
or arising in or related to cases under title 11." Such matters are referred
to the bankruptcy courts by general orders issued on the authority of 28 U.S.C.
§157(a). A party that prefers to proceed in state court typically moves
to remand an action removed by the purchaser or to dismiss an action (such as
an action seeking an injunction) filed by the purchaser in federal court.
The federal courts' analysis of this jurisdictional issue is consistent to
a degree. The courts have not treated post-sale disputes as arising under title
11 or in a title 11 case because the underlying cause of action at issue invariably
arises under nonbankruptcy law and is not unique to bankruptcy.2
The courts that have focused on the "related to" aspect of bankruptcy
jurisdiction have searched for any conceivable effect that the post-sale dispute
might have on the bankruptcy estate or the administration of the case.3
A few courts have stated a firm position against the exercise of jurisdiction
with respect to property that has left the bankruptcy estate.4 Other
courts have been more willing to consider the possibility that jurisdiction
exists, alluding to possible effects on the estate resulting, for example, from
a claim by the purchaser to rescind the sale if the assets it purchased are
not determined to be sufficiently cleansed. However, where estates are already
closed and assets distributed to creditors, the courts have concluded that the
disputes will not have any realistic effect on the estates, and thus that jurisdiction
is lacking.5
In another category of cases, the courts have concluded that the bankruptcy
court's sale order did not bar in fact, or could not have barred for reasons
of due process, the creditor from taking the action at issue against the asset
purchaser.6 Because of the facts of the cases before them, these
courts have not had to define the boundaries of federal jurisdiction.

The courts that have exercised jurisdiction over post-sale disputes generally
have done so without relying on §1334(b). In several cases, courts have
concluded that their jurisdiction to address post-sale disputes arises from
their inherent or ancillary jurisdiction to enforce their own orders.7
In another leading case, the court proceeded to the merits of the dispute without
addressing jurisdiction in any detail.8
The Grable & Sons Case 
Grable & Sons arose in a nonbankruptcy setting. The IRS seized and
sold real property belonging to Grable & Sons Metal Products Inc. (Grable)
to satisfy the company's federal tax obligations. Darue Engineering & Manufacturing
(Darue) purchased the property at the tax sale and received a deed from the
IRS. Five years later, Grable sued Darue in state court to quiet title, contending
that because the governing statute required the IRS to provide notice of the
tax sale by personal service rather than by certified mail, Darue's title was
invalid.

Darue removed the case to federal court, claiming that it fell within federal-question
jurisdiction. Grable sought to have the action remanded, arguing that its cause
of action arose under state law. The district court denied the motion to remand,
and the Sixth Circuit and the Supreme Court affirmed.
In unanimously upholding the exercise of subject-matter jurisdiction despite
the lack of a federal cause of action, the Court relied on a line of cases holding
that "federal question jurisdiction will lie over state-law claims that
implicate significant federal issues."9 These cases, the Court
said, rely on "the common-sense notion that a federal court ought to be
able to hear claims recognized under state law that nonetheless turn on substantial
questions of federal law and thus justify resort to the experience, solicitude
and hope of uniformity that a federal forum offers on federal issues."10
In its discussion of the issue, the Court emphasized that the exercise of jurisdiction
in a particular case must not unduly upset the division of labor between federal
and state courts.11 The Court summarized the inquiry as follows:
"[T]he question is, does a state-law claim necessarily raise a stated federal
issue, actually disputed and substantial, which a federal forum may entertain
without disturbing any congressionally approved balance of federal and state
judicial responsibilities?"12
Applying this test, the Court concluded that Grable's claims justified the
exercise of federal-question jurisdiction. The Court reasoned that the sufficiency
of notice appeared to be the only legal or factual issue in the case; the federal
government's interest in collecting delinquent taxes is strong; certainty is
important if the government is to raise funds from execution sales; the government,
taxpayers and buyers would find it valuable to appear before judges with experience
in federal tax cases; and the rarity of federal tax issues in quiet-title actions
would prevent a major disruption of the division of labor between federal and
state courts.13
Meaning for Bankruptcy Sale Disputes

In an appropriate case, Grable & Sons may provide a federal forum
for the resolution of a post-sale dispute in one of several ways. First, a purchaser-defendant
in a state-court action may be able to remove the case under the general removal
statute14 because of the federal question in the case, even though
the action may not be removable as bankruptcy-related under the bankruptcy removal
statute.15 Second, a purchaser may be able to commence an action
in federal court seeking declaratory or injunctive relief to halt proceedings
in state court. Third, if a proceeding also satisfies "related to"
bankruptcy jurisdiction, the presence of a federal question under Grable
& Sons may prevent the application of the mandatory abstention provisions
of 28 U.S.C. §1334(c)(2).16

Whether any of these strategies will work in a particular case, however, will
depend on the facts and on the court's view of several differences between the
tax issues in Grable & Sons and the bankruptcy issues involved in
the post-sale dispute. One distinction involves the substantiality of the federal
issue present in a post-sale dispute.
The courts have long recognized the importance of the federal government's
tax-collection efforts.17 Bankruptcy sales also present important
policy considerations; the price that a purchaser will be willing to pay in
a §363 sale, and thus the returns to creditors, should be higher if the
"free and clear" aspect of the sale is certain and readily enforceable.18
Most bankruptcy practitioners probably consider value maximization as important
a goal as federal revenue collection, but generalists (including Article III
judges) may disagree.19 In any event, not every post-sale dispute
will involve a federal issue that is substantial in the circumstances of the
case. For example, if it is clear that the bankruptcy judge had the authority
to enter a sale order, and it is also clear that a creditor is violating the
order (for example, a lienholder is pursuing foreclosure), it may be difficult
for the purchaser to demonstrate the existence of a substantial federal question
in dispute.20 Cases involving less-egregious behavior—for example,
disputes about the effect of a bankruptcy court's sale order on unripened personal-injury
claims—are more likely to turn on significant federal issues and thus
be within federal-question jurisdiction.

The federal-state balance issue discussed in Grable & Sons probably
should not be a problem in most post-sale disputes because the number of cases
in which a sale order arguably governs the outcome is extremely small in comparison
to the volume of tort, contract, collection and foreclosure litigation in state
courts.
Finally, at least in the context of removal, the application of Grable &
Sons in a bankruptcy sale dispute may create tension with an earlier Supreme
Court decision, Rivet v. Regions Bank of Louisiana.21 In Rivet,
a bankruptcy trustee sold a debtor's leasehold estate in property free and clear
of liens, but Rivet's lien was never cancelled in the public records.22
Eight years later, Rivet filed suit in state court against the purchaser, seeking
recognition and enforcement of her mortgage.23 The purchaser removed
the case to federal court based on the preclusive effect of the bankruptcy court's
order authorizing the sale free and clear of liens.24 Although the
district and circuit courts upheld removal, the Supreme Court disagreed, holding
unanimously that a federal defense cannot support removal where the plaintiff's
well-pleaded complaint contains no federal question.25

The contrast between Rivet and Grable & Sons highlights the
still-viable distinction between a well-pleaded complaint that raises a federal
question (such as Grable's claim that it did not receive notice required by
a federal statute) and a state-law complaint that prompts a federal defense
or counterclaim (such as Rivet's foreclosure action). Purchaser-defendants faced
with ordinary state-law claims in state court probably should commence new actions
in federal court if they want to obtain a federal resolution of their issues.
Indeed, the purchaser in Rivet did just that after losing in the Supreme
Court and was awarded an injunction.26
Conclusion
In some situations, Grable & Sons may allow for a federal resolution
of a dispute arising from a bankruptcy court's order authorizing the sale of
property free and clear of claims and interests. Convincing a federal court
to exercise jurisdiction on the authority of Grable & Sons probably
will require careful analysis of the facts and circumstances of the case, as
well as persuasive arguments by counsel.27

<hr>
<h3>Footnotes</h3>

1 545 U.S. 308, 125 S.Ct. 2363 (2005). 
2 But see In re Middlesex Power Equip. & Marine Inc., 292 F.3d 61,
68 (1st Cir. 2002) (treating purchaser's action seeking interpretation of sale
order as "arising in" proceeding but affirming bankruptcy court's
decision to abstain); In re Allnutt, 220 B.R. 871, 885 (Bankr. D. Md.
1998) (holding that suit by debtor's wife against purchaser, claiming that she
had interest in property sold by trustee, was within "arising in"
jurisdiction).

3 See Pacor Inc. v. Higgins, 743 F.2d 984, 994 (3d Cir. 1984) (establishing
conceivable-effect test). 
4 See In re Xonics Inc., 813 F.2d 127, 131 (7th Cir. 1987); In re
Hall's Motor Transit Co., 889 F.2d 520, 522 (3d Cir. 1989); In re Lemco
Gypsum Inc., 910 F.2d 784, 789 (11th Cir. 1990). 
5 See Zerand-Bernal Group Inc. v. Cox, 23 F.3d 159, 162 (7th Cir. 1994);
In re Murray Industries Inc., 204 B.R. 74, 77 (Bankr. M.D. Fla. 1995).
But see In re Paris Industries Corp., 132 B.R. 504, 507-08 (D. Me. 1991)
(holding that rescission possibility created "related to" jurisdiction).

6 See In re Mooney Aircraft Inc., 730 F.2d 367, 374 (5th Cir. 1984)
(remarking that a court does not have jurisdiction to enforce an order that
it did not make); In re Savage Industries Inc., 43 F.3d 714, 722-23 (1st
Cir. 1994). 
7 See Paris Industries, 132 B.R. at 508; In re Chateaugay Corp.,
213 B.R. 633, 638 (S.D.N.Y. 1997); In re White Motor Credit Corp., 75
B.R. 944, 947-48 (Bankr. N.D. Ohio 1987); In re Fairchild Aircraft Corp.,
184 B.R. 910, 916 (Bankr. W.D. Tex. 1995), vacated on other grounds, 220 B.R.
909 (Bankr. W.D. Tex. 1998). See, generally, Local Loan Co. v. Hunt,
292 U.S. 234, 239 (1934) (bankruptcy court has ancillary jurisdiction to enforce
discharge); Julian v. Central Trust Co., 193 U.S. 93, 112-13 (1904) (district
court has ancillary jurisdiction to enforce foreclosure decree).

8 See In re All American of Ashburn Inc., 56 B.R. 186, 191 (Bankr. N.D.
Ga. 1986). 
9 Grable & Sons, 125 S. Ct. at 2367 (citing Hopkins v. Walker,
244 U.S. 486 (1917)). 
10 Id. 
11 Id. On this basis, the Court distinguished its decision in Merrell
Dow Pharmaceuticals Inc. v. Thompson, 478 U.S. 804 (1986), on which Grable
relied. In that case, the Court had held that the presence of a federal issue
(the argument that mislabeling in violation of federal law constituted negligence
per se) in a product-liability suit under state law was insufficient
to create federal-question jurisdiction. Id. at 812. In Grable &
Sons, the Court emphasized language from Merrell Dow expressing concern
about an influx of state-law tort cases into federal court. Grable &
Sons, 125 S.Ct. at 2371.

12 Grable & Sons, 125 S.Ct. at 2368. 
13 Id. 
14 28 U.S.C. §1441(a) permits removal of any civil action "of which
the district courts of the United States have original jurisdiction," which
includes federal-question cases under 28 U.S.C. §1331. 
15 28 U.S.C. §1452 permits removal of a claim or cause of action to federal
district court "if such district court has jurisdiction of such claim or
cause of action under §1334 of this title." 
16 Among the requirements for mandatory abstention under §1334(c)(2) is
the requirement that "an action could not have been commenced in a court
of the United States absent jurisdiction under this section." 
17 See, e.g., Flora v. United States, 362 U.S. 145, 175 (1960) (noting
government's "substantial interest in protecting the public purse").

18 See, generally, Reed, Michael H., "Successor Liability and Bankruptcy
Sales Revisited—A New Paradigm," 61 Bus. Law 179 (2005) (proposing
theory to enhance debtors' ability to sell assets free and clear of successor
liability claims). 
19 See Chicago Truck Drivers, Helpers and Warehouse Workers Union
(Independent) Pension Fund v. Tasemkin Inc., 59 F.3d 48, 50 (7th Cir. 1995)
("the potential for chilling [sale prices] does not vary as a function
of a company's precise degree of distress, and there is no reason to accord
the purchasers of formally bankrupt entities some special measure of insulation
from liability that is unavailable to ailing but not yet defunct entities").

20 See Shulthis v. McDougal, 225 U.S. 561, 569 (1912) (a suit does not
raise a federal question "unless it really and substantially involves a
dispute or controversy respecting the validity, construction or effect of [a
federal] law, upon the determination of which the result depends"). Of
course, in jurisdictions recognizing the ancillary jurisdiction of a federal
court to enforce its own orders, the lack of a federal question in such a case
would not preclude the court from acting. See supra note 7 and accompanying
text.

21 522 U.S. 470 (1998). 
22 Id. at 472. 
23 Id. at 473. 
24 Id. 
25 Id. at 475.

26 See Regions Bank of Louisiana v. Rivet, 224 F.3d 483, 493 (5th Cir.
2000), cert. denied, 531 U.S. 1126 (2001). 
27 As this article was being finalized for publication, the Supreme Court decided
Empire HealthChoice Assurance Inc. v. McVeigh, 126 S.Ct. 2121 (2006).
In that case, Empire, which provided health insurance to federal employees,
filed suit in federal court seeking to recover benefits paid to McVeigh, an
insured employee who had settled a tort suit against those responsible for his
injuries. The issue before the Supreme Court was the existence of federal-question
jurisdiction, and a 5-4 majority of the Court concluded that jurisdiction was
lacking. In her majority opinion, Justice Ginsburg rejected the argument of
the United States, as amicus curiae, that Grable & Sons controlled.
The Court emphasized that the question in Grable & Sons was essentially
an issue of law, unlike Empire's claim, and referred to cases like Grable
& Sons as a "slim category."

Journal Authors

Brian C. Walsh

Journal Date

Saturday, July 1, 2006 - 12:00

Bankruptcy Rule

2006

none