Non-Core Claims and Abstention Motions: What Recent Case Law Has Taught Us

Bankruptcy practitioners across the circuits understand these categories of adversary proceedings or contested matters, involving state law claims, that could potentially be subject to bankruptcy jurisdiction: core and non-core proceedings.[1]  For core proceedings, a bankruptcy court may enter “final” orders and judgments.[2]

On the other hand, in non-core proceedings, a bankruptcy court may enter a final appealable order and a judgment, but only if the parties consent.[3]  Without this consent, a bankruptcy court may only submit proposed findings of fact and conclusions of law to the applicable district court, and any final order or judgment may be entered by the district court after considering the bankruptcy judge’s proposed findings and conclusions and after reviewing de novo those matters to which any party has timely and specifically objected.[4] A list of core proceedings is set forth in 28 U.S.C. §§ 157(b)(2)(A)-(P). The analysis of whether a proceeding is core is reviewed on a claim-by-claim basis.[5]

In determining what may constitute a core proceeding, it might be possible to argue that certain state law claims could be subject to bankruptcy jurisdiction as core proceedings, under the so-called “catch-all” provisions — even though they do not constitute one of the listed proceedings that constitute core proceedings under 28 U.S.C. § 157(b)(2)(B)-(N) and (P).[6]

The first catch-all provision, 28 U.S.C. § 157(b)(2)(A), designates as core “matters concerning the administration of the estate,” and the second catch-all provision, 28 U.S.C. § 157(b)(2)(O), designates as core “other proceedings affecting the liquidation of the assets of the estate or the adjustment of the debtor/ creditor or the equity security holder relationship, except personal injury tort or wrongful death claims.”[7]

State law contract and tort claims that do not specifically fall within the categories of core proceedings enumerated in 28 U.S.C. § 157(b)(2)(B)-(N) and (P) could still constitute core proceedings if they arguably fit within the literal wording of the two catch-all provisions.[8]  In order for these state law claims to constitute core proceedings, they must be “inextricably intertwined” with how the bankruptcy estate is administered. The claims cannot have arisen before the bankruptcy filing nor be based upon actions that occurred independent of the administration of bankruptcy assets.[9]

GACN

The chapter 11 debtor, GACN, had filed an adversary proceeding against its insurer seeking declaratory relief determining the parties’ respective rights and liabilities under state law arising from a pre-petition insurance contract. The insurance claim arose from a wrongful-termination lawsuit by GACN’s former employees against GACN, where the former employees successfully obtained a trial judgment in their favor and against GACN in the amount of $1.6 million for compensatory damages and $4 million in punitive damages. Following entry of judgment, GACN filed its chapter 11 case. GACN then filed a complaint, during the post-petition period, in state court against the insurer and its insurance defense counsel for failing to take action to settle the matter prior to trial.[10]

In the GACN case, the former employees, who had obtained the state court judgment, had filed proofs of claim based on the entered judgment. GACN then negotiated a settlement to resolve the judgments (and proofs of claim) with the employees, subject to bankruptcy court and insurer approval. GACN sought insurer approval, which the insurer rejected because GACN had allegedly violated the insurance contract by failing to obtain the insurer’s consent prior to entering into the settlement negotiations with the employees.[11]  The insurer then answered the GACN state court complaint and asserted, as an affirmative defense, that GACN was barred from any recovery against the insurer because GACN had failed to comply with a provision in the insurance contract that required that GACN obtain the insurer’s consent prior to the settlement negotiations with the employees, entering into a fully executed settlement agreement with them.[12]

Next, GACN filed an adversary proceeding against the insurer seeking declaratory relief for a judicial determination of its rights and liabilities arising from the following: (1) its post-petition actions in negotiating a settlement and entering into a settlement with the employees; (2) the insurer’s decision to reject GACN’s request for consent to the settlement; and (3) the insurance contract provision that purportedly barred the action against the insurer for GACN’s failure to comply with the contract and obtain pre-approval for the settlement.[13]  In light of the pending state court action, the insurer filed a motion seeking that the bankruptcy court abstain from hearing GACN’s adversary proceeding. The bankruptcy court denied the motion.

The insurer subsequently appealed the bankruptcy court’s decision to the Ninth Circuit Bankruptcy Appellate Panel (BAP). In its review, the BAP decided that in order to properly determine whether the bankruptcy court abused — or did not abuse — its discretion in denying the abstention motion, the BAP had to review whether the adversary proceeding for declaratory relief was a core or non-core proceeding.[14]  This determination would dictate whether the bankruptcy court could enter a final, appealable ruling (as a core proceeding) or whether consent from the parties was necessary (as a non-core proceeding) for the court to enter a final, appealable ruling. Absent such consent, the bankruptcy court’s ruling could only be memorialized in proposed findings of fact and conclusions of law, which would be subject to de novo review by the district court.

Catch-All Provisions for Core Determination

The BAP determined that state law contract claims did not fall within the enumerated list of core proceedings under 28 U.S.C. § 157(b)(2)(B)-(N), but could arguably fall within the literal wording of the two catch-all provisions in 28 U.S.C. § 157(b)(2)(A) and (O). With respect to the catch-all provisions, the BAP found that post-petition state law claims that arose from conduct that was inextricably intertwined with the administration of the estate could fall within the scope of the “catch-all” provisions.[15]  In other words, and in the converse, state law claims that had arisen prior to the bankruptcy (i.e., pre-petition), and arose from conduct that was independent of the administration of bankruptcy assets, would not constitute core claims that were subject to the catch-all provisions.

In looking at the declaratory relief action that GACN brought against the insurer, the BAP determined that the adversary proceeding was not a core proceeding within the “catch-all” provisions of 28 U.S.C. § 157(b)(2)(A) and (O). GACN’s claims had not implicated any post-petition conduct or claims and did not involve any claims that would be inextricably intertwined with the administration of the estate.

The BAP concluded that the declaratory relief claims were non-core claims and determined that the bankruptcy court had erred in finding that the claims were core for purposes of denying mandatory abstention.[16]  Transitioning from the core to non-core review, the BAP then focused on whether the bankruptcy court had properly denied mandatory abstention based on whether (1) state law governed the underlying claims and (2) the state court could timely adjudicate the dispute relative to the bankruptcy court.

Timeliness of Adjudication of Non-Core Claims in Bankruptcy Court vs. State Court

On the first issue, the BAP determined that the bankruptcy court erred in finding that this factor for mandatory abstention was not satisfied because state law in fact governed the claims. On the second point, the BAP found that the bankruptcy court’s analysis, which found that the timeliness of the adjudication of the dispute favored retention of GACN’s claims in the bankruptcy court, was awed[17]  because the bankruptcy court had erroneously concluded that the claims were core.

With non-core claims, the timeliness factor would have to consider the time delay caused by the bankruptcy court being unable to enter a final ruling and judgment. If the parties did not consent to the bankruptcy court’s jurisdiction, then the bankruptcy court could only submit to the district court proposed findings of fact and conclusions of law subject to de novo review.

In specifically addressing the time-delay issue caused by proceeding with the non-core claims, which are subject to district court de novo review, the BAP stated that the bankruptcy court “might conclude that GACN could obtain a more timely resolution of the issues underlying the declaratory relief action by seeking from the state court summary adjudication of the insurer’s sixth affirmative defense in the state court action.”[18]  In other words, it was the BAP’s view that the state court process could actually be more expedient to resolution, rather than the elongated procedural process for the adversary proceeding, which would be subject to the de novo review of another court.

However, the timeliness factor, as analyzed by the BAP, does not seem to be well defined and is to be determined on a case-by-case basis. The BAP made a statement that succinctly explained the uncertainty of how this timeliness issue could be determined:

Our collective experience as bankruptcy judges indicates that the length of time [that] it takes district courts to complete the review process under 28 U.S.C. § 157(c)(1) varies widely from court to court and district to district. We have no personal knowledge of how long this process might take in the Central District of California on a matter requiring the interpretation of an insurance contract provision.[19]

Based on this determination that the declaratory relief claims were based on state law (and did not implicate bankruptcy law) and that the timeliness factor potentially weighed in favor of remand to the state court, the BAP found that the bankruptcy court had erred in denying the insurer’s motion for mandatory abstention. Consequently, the BAP reversed the bankruptcy court’s finding that the declaratory relief claims were core claims and remanded the decision on the timeliness issue to the bankruptcy court for further consideration.

Implications of the GACN Decision

The GACN case should have implications for future decisions on abstention motions where the adversary proceeding claims involve non-core state law claims. Fundamental to the decision-making for each of these abstention decisions will be the timeliness factor, comparing the judicial process in the bankruptcy court with that of the state court. In nearly every scenario, given the procedural delays caused by a bankruptcy court merely rendering proposed findings of fact and conclusions of law subject to district court de novo review, this may also favor the proceeding being remanded to the state court, where there would be no additional layer of mandatory review. By proceeding in bankruptcy court, a litigant would have to go through two levels of review even before reaching an appellate court, whereas in state court a litigant would only have to go through one level of review prior to reaching an appellate court. Judicial economy may favor in this instance abstention of non-core claims in favor of the state court.

As noted by the BAP, it seems that the case law and experiential basis of the bankruptcy courts have not yet reached a level in the circuits to determine actually how long a non-core claim judicial process would take in the bankruptcy courts and district courts relative to a state court proceeding. Perhaps further data and anecdotal experience from proceedings where the parties have proceeded to this final de novo level of review could be helpful in determining how long such a process would take, and what level of de novo review would be required.

Presumably, a de novo review would require a district court to essentially reconsider the entirety of the adversary proceeding, and possibly reopen discovery and other pretrial motions long after the adversary proceeding has been fully litigated and closed in the bankruptcy court. It seems a specific streamlined procedure would need to take place in order to expedite these matters to be fast-tracked through the bankruptcy court, then to district court for de novo review. Perhaps much of what was litigated and discovered in the bankruptcy court proceeding could be adopted in its entirety into the district court proceedings and record.

The timeliness factor, if this streamlined procedure were effectuated, could potentially rival the timeline for a state court proceeding, in particular where the state court is inundated with litigation matters, has limited resources due to budget and personnel cuts, and cannot proceed with efficiency due to a heavy docket.

Conclusion

In the end, and as a practical matter, seeing an adversary proceeding involving non-core claims being subject to district court de novo review would be a result no party would want. The bankruptcy court would not want its hard-labored proposed findings of fact and conclusions of law overturned by the district court on its de novo review, and the litigants would not want the prospect of a favorable decision to be potentially overturned by the district court. The cost of double litigation would also have to be factored in to the extent that the district court determined that the adversary proceeding would need to start from scratch in the district court. This timeliness issue, relative to proceeding between state and bankruptcy/district courts, for non-core claims will be one that will need to play itself out in the future.

It is too early to determine from present case law how this will ultimately be measured and quantified in order for bankruptcy courts to determine whether it would be more efficient to maintain the matter, or have the matter remanded to state courts. Future decisions that take a more analytical view of this timeliness issue may become more prevalent as abstention motions are filed for proceedings with non-core claims.