Reading Stern Narrowly, Delaware Judge to Issue Final Order in Fraudulent Transfer Suit

Narrowly interpreting Supreme Court authority, Chief Bankruptcy Judge Christopher S. Sontchi of Delaware disagreed with the Ninth Circuit and several district courts by holding that the bankruptcy court has constitutional authority to enter a final judgment in a fraudulent transfer suit against a defendant who neither filed a claim nor consented to final adjudication in bankruptcy court.

Judge Sontchi concluded that the Supreme Court has not explicitly ruled that Sections 157(b)(1) and (b)(2)(H) are unconstitutional when applied to fraudulent transfer suits against defendants who have not filed proofs of claim. Absent high court authority, he declined to find the statute to be unconstitutional.

When thinking about Judge Sontchi’s opinion, consider this question: Did he ignore an obvious implication of Stern v. Marshall, 564 U.S. 462 (2011)?

The Suit by the Creditors’ Trust

The Paragon Offshore PLC chapter 11 plan created a trust to pursue claims on behalf of creditors. The trust filed suit after confirmation to recover allegedly fraudulent transfers that occurred before Paragon’s chapter 11 filing.

The defendants filed a motion asking Judge Sontchi to declare that he could only enter proposed findings of fact and conclusions of law. Judge Sontchi denied the motion in a scholarly March 11 opinion that surveys the ups and downs (mostly downs) of bankruptcy courts’ powers following Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982) (plurality opinion).  

Judge Sontchi laid out the statutory framework, beginning with 28 U.S.C. § 157(b)(1), where Congress gave bankruptcy courts power to “hear and determine . . . all core proceedings.” Section 157(b)(2)(H) lists fraudulent transfer suits among “core proceedings.” Thus, the statute permits bankruptcy courts to enter final judgments in fraudulent transfer suits.

By contending that he could not issue a final judgment in a fraudulent transfer suit, Judge Sontchi said that the defendants were asking him to rule that parts of 28 U.S.C. § 157 are unconstitutional.

Granfinanciera and Stern

Judge Sontchi parsed the Supreme Court’s bankruptcy decisions to identify what the justices held and how they limited their opinions. After Marathon Pipe Line, he examined Granfinanciera S.A. v. Nordberg, 492 U.S. 33 (1989), which, he said, was closely related but not binding, even though the facts were “closely analogous.” Like the case at bar, Granfinanciera involved a fraudulent transfer suit against a defendant who had not filed a claim. The high court ruled that the defendant was entitled to a jury trial.

Judge Sontchi said that Granfinanciera at bottom was a Seventh Amendment case involving the right to a jury trial, not an Article III case regarding the constitutional limitations on the powers of bankruptcy judges. He said that Granfinanciera “alone” did not compel him to rule that Section 157(b)(2) violates Article III of the Constitution.

Judge Sontchi said that Granfinanciera “intentionally and explicitly refrained from extending its opinion to the constitutionality of the entry of final orders by bankruptcy courts pursuant to [Section 157] — the very issue before this Court today.”

Next, Judge Sontchi turned to Stern. Like Granfinanciera, he said that Stern “does not bind lower courts on issues that were not directly before it.”

While “its rhetoric may have been at points, sweeping,” Judge Sontchi said that Stern’s “ultimate holding was not.” Rather, he alluded to how the Chief Justice said that Stern should little affect the distribution of work between district and bankruptcy judges.

Stern, Judge Sontchi said, “included a crystal-clear statement that ‘Congress, in one isolated respect, exceeded’ its Article III power when passing the 1984 Amendments — and that ‘isolated’ issue is not the issue before this Court today.”

Nodding to the Ninth Circuit and other courts that have ruled otherwise, Judge Sontchi said, “Perhaps Stern provides compelling evidences of how the Supreme Court would rule on this issue if it were to address it directly, but it does not decide it.” [Emphasis in original.]

Since neither Stern nor Granfinanciera were controlling, Judge Sontchi said that the defendants “are not asking this Court to apply controlling precedent to the matter at hand. Instead, Movants are asking this court to extend the holdings of those cases, in order to find that 28 U.S.C. § 157(a) is unconstitutional to the extent it directs bankruptcy judges to enter final orders in fraudulent transfer claims against parties who have not filed claims against the bankruptcy estate. The Court decline to make that leap.” [Emphasis in original.]

Judge Sontchi made two other notable rulings. First, he held that a claim for unjust enrichment is noncore even when the claim is based on the same facts as a fraudulent transfer claim that is core. He also held that the defendants had not waived their objections to the final adjudicatory power of the bankruptcy court by participating in the formulation of the plan.

Observations

Stern found a constitutional infirmity insofar as Section 157 lodged final adjudicatory authority in the bankruptcy court over a counterclaim based on a tortious interference claim under state law. Stern did not deal with a fraudulent transfer counterclaim.

So, the question is: Given the 5/4 ruling in Stern that Section 157(b)(2)(C) was unconstitutionally applied to the facts of the case before the Supreme court, does it follow ineluctably that Section 157(b)(2)(H) is also unconstitutional when the defendant has not filed a claim or consented to final adjudication in bankruptcy court?

In this writer’s view, Stern does imply that Section 157(b)(2)(H) is also unconstitutional on the facts of a case like that before Judge Sontchi. However, keep in mind that Stern was a 5/4 decision. Also recall that none of the opinions in Marathon Pipe Line commanded a majority of the justices.

It is therefore not a foregone conclusion that the Supreme Court will assuredly rule that Section 157(b)(2)(H) is unconstitutional when and if the question is squarely presented. It is possible that the high court will draw a line and say that the Court has gone far enough in eroding the powers of bankruptcy judges. However, don’t hold your breath.