A decision by a district judge in Detroit prompts the reader to question the continuing validity of a series of opinions by the Supreme Court in the first half of the 20th century holding that a bankruptcy judge has constitutional authority to enter final judgment directing turnover of property when the defendant third party has a merely colorable claim to ownership.
The opinion means that a bankruptcy court can create final adjudicatory power for itself by making requisite findings of fact without having them reviewed de novo by a district judge.
District Judge Matthew F. Leitman based his decision on the concept of summary jurisdiction under the former Bankruptcy Act and, in large part, on the dissenting opinion by Chief Justice John G. Roberts Jr. in Wellness International Network Ltd. v. Sharif on an issue where a majority of the Supreme Court were silent.
The Facts
Years before a man filed a chapter 7 petition, he had set up a not-for-profit corporation to acquire historically important documents. Initially, the trustee filed an adversary proceeding alleging that the corporation received fraudulent transfers from the debtor. After discovery, the trustee changed course and filed a turnover motion under Section 542(a) alleging that the corporation was in possession of property belonging to the debtor.
After a trial with witnesses, the bankruptcy judge entered a final turnover order concluding, among other things, that the debtor owned the disputed property because he had “comprehensively comingled his financial affairs with those” of the corporation.
Contending that the bankruptcy judge had no jurisdiction to enter a turnover order, the corporation appealed, only to lose in Judge Leitman’s Oct. 6 opinion.
The Resurrection of Summary Jurisdiction
Judge Leitman said that the “parameters of bankruptcy court jurisdiction” under the Act are “especially helpful” in discerning the limits of “modern bankruptcy court jurisdiction.” He focused on the distinction between summary and plenary jurisdiction under the Act.
Before adoption of the Bankruptcy Code in 1978, bankruptcy courts, according to Judge Leitman, had summary jurisdiction to enter a final order, without consent, resolving title to property when the debtor or the trustee had possession. Similarly, there was summary jurisdiction, he said, when the debtor had constructive possession.
Significantly, Judge Lietman said there would be constructive possession under Taubel-Scott-Kitzmiller Co. v. Fox, where the Supreme Court found constructive possession in 1924 when the third party’s claim to ownership was “colorable only.” Conversely, there was no constructive possession when the third party raised a “substantial claim” to ownership.
Sampsell v. Imperial Paper & Color Corp. was also important, Judge Leitman said, because the Supreme Court held in 1941 that “a mere alter ego” cannot make a substantial adverse claim. In other words, finding someone to be an alter ego would convert a plenary proceeding into a summary proceeding.
Consequently, Judge Leitman concluded that the bankruptcy court would have had summary jurisdiction under the Act to enter a final turnover order because the corporation’s claim was “entirely baseless and, thus, merely ‘colorable.’”
Applying Code Concepts
Under the Code, Judge Leitman held that the turnover motion was “core” because the corporation’s claim to ownership was “entirely baseless.”
Even though the dispute was “core,” he then examined whether the bankruptcy court had final adjudicatory power under Stern v. Marshall. At that juncture, he relied in large part on the Chief Justice’s dissent in 2015 in Wellness International, where a bare majority of the Court held that actual or implied consent enables a bankruptcy judge to make final decisions on matters that otherwise would only be within the purview of a federal district judge.
While dissenting on the consent issues, the Chief Justice made a pronouncement that, if adopted by the entire court, would expand the powers of bankruptcy judges in one respect. He said a bankruptcy court has the power to make a final decision on disputed ownership of property as long as there are no adverse claims by third parties. The majority expressed “no view” on that issue.
Judge Leitman cited the Chief Justice’s dissent as confirmation that the final turnover order did not offend the Constitution because it “was fully consistent with the historical exercise of core bankruptcy jurisdiction.”
In particular, Judge Leitman quoted from the Chief Justice’s dissent where he distinguished an alter ego claim from a fraudulent transfer claim. In that respect, the Chief Justice said that a fraudulent transfer claim “seeks assets in the hands of a third party, while an alter ego claim targets only the debtor’s ‘second self.’”
The Supreme Court “came with something that is workable under the 1898 Act and it’s not clear why we should be trying to reinvent the wheel,” Prof. Ralph Brubaker told ABI in an interview. In his opinion, Judge Leitman copiously quoted scholarly writings by Prof. Brubaker, who is the Carl L. Vacketta Professor of Law at the University of Illinois College of Law.
Interpreting the Opinion
Judge Leitman’s opinion could be read to mean that a bankruptcy court has final adjudicatory power in piercing the corporate veil or holding someone to be the debtor’s alter ego. In other words, a bankruptcy court’s findings of fact, although not reviewed de novo, create constitutional power to enter a final order, at least when there is no substantial evidence to justify the third party’s claim to ownership.
Arguably, denial of alter ego or corporate veil arguments would not be final under Judge Leitman’s analysis, assuming that the presence of substantial facts implicates Article III powers.
If the third party’s claim to ownership is more than colorable, it is unclear whether Judge Leitman would find final power to enter a turnover order. By citing the Chief Justice’s Wellness International dissent, however, Judge Leitman’s opinion might be read to imply that any alter ego claim gives rise to a final order, even if there is substantial evidence of adverse ownership.
Judge Leitman also held that the corporation had no right to a jury trial. Procedurally, he said that an adversary proceeding was not required, and if it was, the corporation suffered no prejudice.
Revisiting Prior Supreme Court Holdings
It is not entirely clear that Taubel-Scott-Kitzmiller and Sampsell remain good law in the wake of Stern v. Marshall and its progeny. In the 21st and late 20th centuries, the Supreme Court has been more protective of the prerogatives of Article III judges and less prone to allowing bankruptcy judges to exercise the full panoply of judicial powers. Still, there is no indication from Northern Pipeline and later cases that the Supreme Court is inclined to repudiate opinions from 100 years ago placing limits on the powers of bankruptcy referees, even though those decisions were not couched in constitutional terms.
Judge Leitman’s opinion would be an ideal vehicle for testing whether venerable Supreme Court authorities from the early 20th century were impliedly overruled by a more restrictive notion of constitutional limitations on the powers of bankruptcy courts. The chances of an appeal are remote because Judge Leitman said he would reach the same result under de novo review if the issue were non-core.
Judge Leitman is a graduate of Harvard Law School and was appointed to the district court in 2016.