The Delaware Bankruptcy Court Once Again Adopts the Narrow View of Stern v. Marshall

Does a bankruptcy court have the power to enter a final order in a fraudulent-transfer action where the defendant has not filed a proof of claim, or is the bankruptcy court limited to submitting proposed findings of fact and conclusions of law to the district court for de novo review and entry of judgment? On March 11, 2019, in Paragon Litigation Trust v. Nobel Corp., et al. (In re Paragon Offshore PLC, et al.),[1] Delaware Chief Bankruptcy Judge Christopher S. Sontchi answered this question in the affirmative, putting the Delaware bankruptcy court in contrast with other courts across the country more broadly interpreting Stern v. Marshall. The Paragon decision is in line with existing Delaware cases.[2]

The Broad and Narrow Views of Stern v. Marshall

In Stern v. Marshall, the Supreme Court held that even though 28 U.S.C. § 157(b)(2)(C) provides that a bankruptcy court can enter a final order in connection with “counterclaims by the estate against persons filing claims against the estate,” the U.S. Constitution does not.[3] One of the major questions on which courts have disagreed ever since is whether the statements and logic of Stern v. Marshall and subsequent Supreme Court cases necessarily also mean that even though 28 U.S.C. § 157(b)(2)(H) provides that a bankruptcy court can enter a final order in connection with “proceedings to determine, avoid, or recover fraudulent conveyances,” the U.S. Constitution likewise does not.

A number of courts, including the Ninth Circuit and several district courts, have adopted the broad view, holding that, absent consent, bankruptcy courts do not have the power to enter final judgment in fraudulent-transfer actions against a defendant that did not file a proof of claim.[4] According to these courts, when the issue is finally squarely presented to the Supreme Court, it will rule that when a defendant in a fraudulent transfer action has not filed a proof of claim, not only does the defendant have the Seventh Amendment right to a jury trial, but the bankruptcy court also does not have the power to enter final judgment.[5] That is, the tests for when a defendant has the right to a jury trial and when the bankruptcy court has the power to enter a final order in a fraudulent transfer action are the same. These courts premise their view on the language and logic of Stern and, in particular, its discussion of Granfinanciera S.A. v. Nordberg,[6] concluding that “a fraudulent conveyance claim against a person who has not submitted a claim against a bankruptcy estate, brought solely to augment the bankruptcy estate, is a matter of private right.”[7] According to these courts, bankruptcy courts lack final adjudicative authority over even a “core” claim where (1) the claim at issue does not fall within the “public rights” exception, (2) the claim would not necessarily be resolved in ruling on the defendant’s proof of claim, and (3) the parties have not unanimously consented to final adjudication of the claim by the bankruptcy court.[8]

The narrow view focuses on the language in Stern indicating that it only found that Congress exceeded its authority in “one isolated respect.”[9] According to narrow-view courts, taking away the power to enter final orders in fraudulent-transfer actions would, by contrast, represent a sweeping change. These courts also are of the view that it is not appropriate to extend Stern based on its arguable dicta.

The Paragon Bankruptcy Court Embraces the Narrow View

The Paragon court has embraced the narrow view of Stern. It emphasized that Stern and subsequent Supreme Court cases have not specifically held that bankruptcy courts may not enter final judgment in fraudulent-transfer actions when the defendant has not filed a proof of claim.[10] According to the Paragon court, assuming that Congress violated the U.S. Constitution in permitting bankruptcy judges to enter final orders in fraudulent-transfer actions, the ruling violates “[t]he general principle of judicial restraint,” and the Paragon court countered that “‘[f]ederal statutes are presumed constitutional’” and that “[e]very legislative act is to be presumed to be a constitutional exercise of legislative power until the contrary is clearly established….’”[11] The Paragon court further noted that “while Stern characterizes (perhaps mischaracterizes) the Granfinanciera opinion repeatedly, it does not seem to rely on that opinion for its ultimate, narrow conclusion.”[12] The court asserted that the broad view “is by no means inescapably correct.”[13] In a subsequent case, Executive Benefits Insurance Agency v. Arkison, the Supreme Court in fact acknowledged but did not decide the question, demonstrating that Stern must have left the question open.[14] The Paragon court went on to note that “[p]erhaps Stern provides compelling evidence of how the Supreme Court would rule on this issue if it were to address it directly, but it does not decide it.”[15] “Because neither Stern nor Granfinanciera control on this issue, Movants are not asking this Court to apply controlling precedents 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 that 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 declines to make that leap.”[16]

Looking to the Future

Will the Paragon decision stem the tide and lead to broader adoption of the narrow view of Stern? Only time will tell. The only thing that seems clear is that the issue will not be finally decided until the Supreme Court takes it up, and how the Supreme Court will come out is far from clear. The Supreme Court has failed to issue the sorts of broad rulings following Stern that the language of Stern itself might predict, a point vigorously noted in the dissent of Chief Justice Roberts in Wellness International Network Ltd. v. Sharif.[17] Moreover, we now have two new justices of the Supreme Court who have yet to speak on the issue, both of whom replaced justices who were in the Stern majority. For now, at a minimum, the Paragon decision bolsters the existing case law in Delaware holding that bankruptcy judges may enter final orders in fraudulent-transfer actions where the defendant has not filed a proof of claim — whether or not the defendant has expressly or impliedly consented to that.