To Infinity and Beyond Related to Related to Jurisdiction Supplemental Jurisdiction of Bankruptcy Courts

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Jun 2005

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In the recent decision of In re Pegasus
Gold Corp., 394 F.3d 1189 (9th Cir. 2005), the Ninth Circuit Court
of Appeals became the first circuit court to unequivocally hold that
bankruptcy courts can exercise supplemental jurisdiction pursuant to 28
U.S.C. §1367 over "non-core," un-"related to" claims. The Ninth
Circuit's decision in Pegasus stretches the bankruptcy courts'
jurisdiction to seemingly limitless bounds and, as one court has
prophesized, may result in running another

Marathon.<a href="#1" name="1a">1</a>

<h4>The Well-known Limits</h4>

As every bankruptcy practitioner knows, as Article I courts,
bankruptcy courts are courts of limited jurisdiction, with their reach
defined by statute. In Northern Pipeline Construction Co. v. Marathon
Pipe Line Co., 458 U.S. 50, 102 S.Ct. 2858 (1982), the Supreme Court
held that it was unconstitutional to vest full and final authority over
any matter conceivably related to a bankruptcy case in an Article I
judge because, under the Constitution, the "judicial power" of the
United States, if vested in lower federal courts at all, must be vested
in courts with Article III safeguards. In so holding, the Supreme Court
acknowledged that Congress may provide the bankruptcy courts with
authority over proceedings that are so closely related to substantive
bankruptcy law and procedures that they can be said to be "core"
bankruptcy matters. However, the Supreme Court also ruled that Congress
may not give Article I judges the power to render final judgments over
matters that are not directly connected to the Bankruptcy Code.

In response to the Supreme Court's directive in Marathon,
Congress enacted 28 U.S.C. §§157 and 1334. Section 1334(a)
confers upon the district courts "original and exclusive jurisdiction of
all cases under Title 11." Section 1334(b) adds that "the district
courts shall have original, but not exclusive, jurisdiction of all civil
proceedings arising under Title 11, or arising in or related to cases
under Title 11." Section 157(a) in turn provides that the district
courts may refer their bankruptcy jurisdiction to bankruptcy courts.

Generally speaking (assuming an order of reference has been entered
by the district court), bankruptcy court jurisdiction is bifurcated into
"core" and "related to" matters. Core proceedings are those that are
"predicated on a right created by a provision in Title
11."<a href="#2" name="2a">2</a> Stated
otherwise, core proceedings are those proceedings that involve a cause
of action or administrative matter created or determined by a statutory
provision of Title 11.<a href="#3" name="3a">3</a> Core proceedings have no existence outside
a bankruptcy case. In each case, a bankruptcy court has the authority to
hear and determine a "core" claim without the necessity of any
involvement by the district court.

In addition to "core" claims, a bankruptcy judge may hear a
proceeding deemed to be a "non-core" proceeding under 28 U.S.C.
§157 if the claim is otherwise "related to" a case under Title 11.
However, absent the parties' consent, the bankruptcy judge may not enter
a final judgment on such non-core, related-to claims, but rather must
submit proposed findings of fact and conclusions of law to the district
judge, who then must review such findings and conclusions de
novo.<a href="#4" name="4a">4</a>

The most common definition of a "related to" proceeding is one where
"the outcome of the action could conceivably have any effect on the
estate being administered in bankruptcy."<a href="#5" name="5a">5</a> Stated another way, "an action is related
to bankruptcy if the outcome could alter the debtor's rights,
liabilities, options or freedom of action (either positively or
negatively) and which in any way impacts upon the handling and
administration of the bankruptcy estate."<a href="#6" name="6a">6</a> An example of a "related to" matter would
be a common state law claim that a debtor has against a third party,
such as a lawsuit against a director of a debtor corporation for breach
of fiduciary duties.

Under 28 U.S.C §§157 and 1334, if a matter is neither a
core proceeding nor a related-to proceeding, then a bankruptcy court
does not have subject matter jurisdiction to consider the matter. After
all, bankruptcy courts receive their entire jurisdictional manna from
the district courts, and nowhere does §157(a) authorize the
district courts to delegate more than core and related-to jurisdiction
to the bankruptcy courts.

<h4>Stretching the Limits</h4>

But of course, the story does not end there. Some lower
courts,<a href="#7" name="7a">7</a> and now
the Ninth Circuit Court of Appeals, have employed the supplemental
jurisdiction statute of 28 U.S.C. §1367 to stretch the limited
jurisdiction of the bankruptcy courts to seemingly infinite bounds. 28
U.S.C. §1367(a) provides as follows:

<blockquote>
Except as provided in subsections (b) and (c) or as expressly provided
otherwise by federal statute, in any civil action of which the district
courts have original jurisdiction, the district courts shall have
supplemental jurisdiction over all other claims that are so related to
claims in the action within such original jurisdiction that they form
part of the same case or controversy under Article III of the U.S.
Constitution. Such supplemental jurisdiction shall include claims that
involve the joinder or intervention of additional parties.
</blockquote>

In a nutshell, §1367 allows a federal district court to consider
claims that it would otherwise not have jurisdiction over so long as
those claims arise out of the same nucleus of operative fact as a claim
over which the district court does have original subject-matter
jurisdiction. As stated by one court, the jurisdictional grant under
§1367 is an extremely broad grant of authority that extends the
jurisdiction of the district court to the very limits of Article III of
the Constitution.<a href="#8" name="8a">8</a>

In In re Pegasus Gold Corp., 394 F.3d 1189 (9th Cir. 2005),
the Ninth Circuit Court of Appeals became the first circuit court to
unequivocally extend the jurisdictional reach of 28 U.S.C. §1367
beyond the district courts and allowed supplemental jurisdiction to be
exercised by the bankruptcy court. In Pegasus, a chapter 11
debtor owed certain environmental compliance and clean-up obligations to
the state of Montana in connection with two mines operated by the debtor
in that state. After extensive negotiations between the parties, they
agreed that the debtor would form a new corporate entity that would
perform reclamation work for the state at the subject mines. The
settlement agreement further provided that the debtor would provide the
new entity with $1 million in working capital and also transfer over $1
million to the state of Montana to help pay for the reclamation work.
The terms of the settlement agreement were incorporated into the
debtor's confirmed chapter 11 plan. The parties executed a formal work
agreement, and the new entity began the reclamation process. The
parties' working relationship quickly soured however, and within two
months the state of Montana hired another unrelated entity to perform
the reclamation work. The liquidating trustee then brought an adversary
proceeding against the state of Montana alleging a number of contract
claims stemming from the state's alleged breach of the settlement
agreement and the debtor's chapter 11 plan. As part of that adversary
proceeding, the trustee also joined as a party defendant the new entity
that the state had hired to complete the reclamation work, asserting
claims for tortuous interference and conversion against it. The new
entity moved to dismiss these claims, arguing that the bankruptcy court
lacked subject matter jurisdiction over the claims against it. The
bankruptcy court determined that it had supplemental jurisdiction to
consider the claims against the new entity. Both the district court and
the Ninth Circuit affirmed that decision on appeal.

By authorizing the utilization of supplemental jurisdiction in
bankruptcy courts in Pegasus, the Ninth Circuit has, in effect,
disregarded the limiting referral language of 28 U.S.C. §157(a) and
has authorized bankruptcy courts to exercise jurisdiction over claims
that have no conceivable relation to the bankruptcy case or the
administration of the bankruptcy estate. In essence, bankruptcy courts
(at least those in the Ninth Circuit) can now exercise jurisdiction over
claims that are related to related-to or core matters.<a href="#9" name="9a">9</a>

Although the exercise of supplemental jurisdiction by bankruptcy
courts undoubtedly serves judicial economy by bringing all related
claims to a comprehensive and consistent conclusion, efficiency and
uniformity alone ought not supersede specific statutory limits on
bankruptcy court jurisdiction.<a href="#10" name="10a">10</a> The Ninth Circuit's holding in
Pegasus not only supplants the careful congressional construct of
28 U.S.C. §157, limiting bankruptcy jurisdiction to core and
related-to matters, but also cuts against the Supreme Court's directive
that courts not "read jurisdictional statutes
broadly."<a href="#11" name="11a">11</a>

<h4>Conclusion</h4>

To date, the only circuit appeals court other than the Ninth Circuit
that has considered the question of whether bankruptcy courts are
authorized to exercise supplemental jurisdiction under 28 U.S.C.
§1367 is the Fifth Circuit. In In re Walker, 51 F.3d 562,
573 (5th Cir. 1995), the Fifth Circuit reached a decision contrary to
that in Pegasus, concluding that bankruptcy courts cannot
exercise supplemental jurisdiction to hear non-core unrelated-to
claims.<a href="#12" name="12a">12</a> Due to
the split in the circuits, perhaps the Supreme Court will someday step
into the fray and, as cleverly articulated by the bankruptcy court in
Remington Development, "run another
Marathon."<a href="#13" name="13a">13</a> In the meantime, the watchword of Buzz
Lightyear of Disney/Pixar (Toy Story) fame aptly summarizes the
jurisdictional reach of the bankruptcy courts in the Ninth Circuit: "to
infinity and beyond."

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> In re Remington
Development Group Inc., 180 B.R. 365, 373 (Bankr. D. R.I. 1995). <a href="#1a">Return to article</a>

<a name="2">2</a> Drexel Burnham Lambert
Group Inc. v. Vigilant Insurance Co., 130 B.R. 405, 407 (S.D.N.Y.
1991). <a href="#2a">Return to article</a>

<a name="3">3</a> 28 U.S.C. §157(b)(2)
lists a litany of matters that are core proceedings. <a href="#3a">Return to article</a>

<a name="4">4</a> 28 U.S.C.
§157(c)(1). <a href="#4a">Return to article</a>

<a name="5">5</a> In re Fietz, 852
F.2d 455, 457 (9th Cir. 1988). <a href="#5a">Return to article</a>

<a name="6">6</a> In re Pegasus Gold
Corp., 296 B.R. 227, 234 (Bankr. D. Nev. 2003). <a href="#6a">Return
to article</a>

<a name="7">7</a> See, e.g., In re
Eads, 135 B.R. 387 (Bankr. E.D. Cal. 1991); In re W.J. Servs.
Inc., 139 B.R. 824, 826 (Bankr. D. Tex. 1992). <a href="#7a">Return
to article</a>

<a name="8">8</a> Sullivan v.
Metro-North Railroad Co., 179 F.Supp.2d 2, 5 (D. Conn. 2002). <a href="#8a">Return to article</a>

<a name="9">9</a> In addition to
authorizing supplemental jurisdiction over state law claims, the
Pegasus court also determined that pursuant to 28 U.S.C.
§1367, a bankruptcy court is authorized to exercise supplemental
jurisdiction over parties even when that party is not subject to the
federal claim primarily at issue. Pegasus, 394 F.3d at 1195 n.2.
The Pegasus court's holding in this regard deepens the
jurisdictional quagmire even more because it exposes litigants to the
nationwide reach of the bankruptcy courts as far as personal
jurisdiction is concerned, even though the litigant may have had no
connection or contact whatsoever with the debtor or the state where the
debtor's bankruptcy is pending. <a href="#9a">Return to article</a>

<a name="10">10</a> Accord, In re
Remington Development Group Inc., 180 B.R. 365, 374-75 (Bankr. D.
R.I. 1995). It is worth noting that a different analysis may apply and
that the exercise of supplemental jurisdiction may be appropriate when a
district court (as opposed to a bankruptcy court) is presiding over a
particular bankruptcy case or matter. Accord, Allen v. Kuhlman
Corp., __ B.R. __, 2005 WL 701063 (S.D. Miss. 2005); Liberty Mut.
Ins. Co. v. Lone Star Industries Inc., 313 B.R. 9, 21 (D. Conn.
2004). <a href="#10a">Return to article</a>

<a name="11">11</a> Finley v. United
States, 490 U.S. 545, 549, 109 S.Ct. 2003, 2007 (1989). <a href="#11a">Return to article</a>

<a name="12">12</a> See, also, In re
Bass, 171 F.3d 1016, 1024 (5th Cir. 1999). <a href="#12a">Return to
article</a>

<a name="13">13</a> See n. 1,
supra. <a href="#13a">Return to article</a>

Journal Authors

Daniel C. Bruton

Journal Date

Wednesday, June 1, 2005 - 12:00

Bankruptcy Rule

2005

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