Stern v. Marshall: The Aftermath

Although several months have now passed since the Supreme Court first decided Stern v. Marshall, parties to bankruptcy cases nationwide are still absorbing the impact of the decision on the authority of bankruptcy courts to determine certain disputes in bankruptcy cases and to render final judgments.[1] Much of the current confusion can be attributed to the wide gulf separating Stern’s majority and dissenting opinions, but the Supreme Court’s prior forays into this area also deserve some of the blame. As an exasperated Justice Scalia noted in his concurring opinion, “[t]he sheer surfeit of factors that the Court was required to consider in this case should arouse the suspicion that something is seriously amiss with our jurisprudence in this area.”[2] From the Stern majority’s perspective, its decision couldn’t have been clearer. But as everyone knows, even narrow holdings can have unintended consequences.

The Facts
Stern v. Marshall arose out of a decades-long dispute over the inheritance of the late J. Howard Marshall’s fortune. While J. Howard was still living, his wife Vickie filed suit in Texas probate court alleging that J. Howard’s son, Pierce, fraudulently induced his father to sign a living trust that did not include her. J. Howard died shortly thereafter, forcing Vickie to file for bankruptcy in California. Pierce filed a claim against Vickie in the bankruptcy case, asserting that Vickie’s allegations of fraud defamed him, as well as an adversary proceeding seeking a determination that his defamation claim was not dischargeable in bankruptcy. Vickie counterclaimed, alleging tortious interference with the gift she expected from J. Howard.

The bankruptcy court ruled against Pierce and in favor of Vickie, awarding Vickie well north of $400 million in compensatory and punitive damages. Pierce appealed that decision to a district court in California. Meanwhile, parallel proceedings before a Texas probate court – which were not stayed by the bankruptcy proceedings – were building toward their own stunning conclusion: a decision in favor of Pierce. Back in California, the district court ignored the Texas decision and affirmed the bankruptcy court’s ruling in favor of Vickie.

The parties’ subsequent litigation over the effect of these discordant rulings far exceeds the scope of this article. The abbreviated version goes something like this: The Ninth Circuit vacated the district court’s judgment, causing the Supreme Court to intervene by reversing and remanding the case back to the Ninth Circuit. On remand, the Ninth Circuit held that Vickie’s counterclaim for tortious interference was not a core bankruptcy proceeding because its resolution was not necessary to resolve Pierce’s defamation claim. This compelled the Supreme Court to grant certiorari a second time in hopes of resolving this matter once and for all.

The Holding
The Supreme Court framed the issues before it as follows: “(1) whether the Bankruptcy Court had the statutory authority under 28 U.S.C. § 157(b) to issue a final judgment on Vickie’s counterclaim; and (2) if so, whether conferring that authority on the Bankruptcy Court is constitutional.”[3]

The Supreme Court answered the first question in the affirmative. Title 28 U.S.C. § 157(b)(2)(C) states that “counterclaims by the estate against persons filing claims against the estate” are among the “core” proceedings that a bankruptcy court may hear and determine. The Supreme Court determined that Vickie’s counterclaim met this definition, and that therefore the bankruptcy court possessed statutory authority to resolve it. But the Supreme Court wasn’t finished. Having just decided that § 157(b)(2)(C) empowered the bankruptcy court to hear and determine Vickie’s counterclaim, the Supreme Court went on to hold that this statutory grant of bankruptcy court power was unconstitutional.[4]

Specifically, the Supreme Court held that the bankruptcy court, as a non-Article III court, “lacked the constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor’s proof of claim.”[5] Therefore, although Congress had previously denominated these types of proceedings as core – and thus authorized federal bankruptcy courts to hear and decide them – Stern concluded that a latent constitutional defect prohibited Congress from doing so.

Two Dueling Opinions
The majority opinion described Stern’s holding as a narrow one, and in a sense, it is.[6] After all, the majority carefully noted that it does “not think the removal of counterclaims such as [the debtor’s] from core bankruptcy jurisdiction meaningfully changes the division of labor in the current statute” and that “the question presented [in Stern] is a ‘narrow’ one.”[7] Further, the Court’s holding is limited to one small subsection of a much larger section, and that section itself is only one isolated provision in the vast sea of statutes that comprise the multifaceted chapters of the Bankruptcy Code. Bankruptcy courts can still enter final judgments on many familiar bankruptcy disputes, such as preference counterclaims, the claims-allowance process, contract rejection and assumption and violations of the automatic stay. Even if a state law counterclaim is not a “core proceeding,” but is otherwise related to a case under title 11, a bankruptcy judge can always submit proposed findings of fact and conclusions of law to the district court.

The dissent was singularly nonplussed with the majority’s assurances that, as a practical matter, Stern “does not change all that much.”[8] Justice Breyer’s dissenting opinion cited the frequency of similar disputes, the “staggering” volume of bankruptcy cases (approximately 1.6 million filings in 2010 compared with approximately 358,000 federal district court cases for the same period) and the fact that compulsory counterclaims are frequently premised on the same factual disputes as the claims asserted against bankruptcy estates that the bankruptcy courts are authorized to adjudicate.[9] In closing, Justice Breyer warned that this “constitutionally required game of jurisdictional ping-pong between courts would lead to inefficiency, increased cost, delay, and needless additional suffering among those faced with bankruptcy.”[10]

Other Provisions Affected

The confusion surrounding Stern has coalesced into a jurisdictional tug-of-war between opposing parties to pull different matters in and out of bankruptcy court. This is because, as the dissent quite presciently pointed out, the reasoning that the majority employs in reaching its narrow holding is actually quite broad. Essentially, Stern conflates “arising in” and “related to” jurisdiction by specifically invalidating one statutorily defined “core proceeding” while opening the door to contests over other such defined proceedings within 28 U.S.C. § 157(b)(2). For example, the same reasoning precluding a bankruptcy court from entering final judgment on a state law counterclaim can be applied to state law claims under § 157(b)(2)(H), which pertains to fraudulent-conveyance actions. After all, the Supreme Court has already deemed fraudulent-conveyance actions as “quintessentially suits at common law.”[11] Similarly, § 157(b)(2)(K), which pertains to determination of the validity, extent and priority of liens, will be heavily scrutinized because liens are typically determined by reference to state law. These are just two of the more obvious examples from the Bankruptcy Code suggesting that Stern’s holding may be more expansive than the majority might have originally intended.

Increased Delay

One of the most troubling aspects of Stern is its failure to provide practitioners and judges with any guidance on how to apply its holding procedurally. Constitutional issues do not always neatly present themselves for disposition at the inception of every case. Subject-matter jurisdiction may not be waived or consented to; indeed, a party may contest subject-matter jurisdiction at any time during most legal proceedings, and the court itself has an independent obligation to satisfy its doubts over jurisdiction by raising the question sua sponte. However, after Stern, bankruptcy judges may discover that they lack the constitutional authority to hear a case only after the parties have contributed substantial time and resources towards litigating it.

Bankruptcy courts have proven themselves to be efficient arbiters in resolving complex cases. Depending on the issues presented, Stern may allow matters traditionally decided in front of one judge to fragment into lengthy and costly multidistrict litigation in courts across the country. And while Stern forces district courts to confront these types of issues, district courts already have their hands full with keeping their current dockets under control. The confusion surrounding these procedural issues is unlikely to be alleviated until Article III courts have had a chance to weigh in, and in particularly overburdened districts, that could take years.

Litigation Strategy
Retroactivity

Although Stern sheds little light on how its holding ought to be applied, the Supreme Court has previously ruled that res judicata applies to bankruptcy court orders no longer subject to appellate review, even if the bankruptcy court did not actually have the power to issue them.[12]  Thus, final bankruptcy court orders no longer subject to appellate review should remain enforceable. Orders to which litigants did not raise Article III, § 1 objections below will likely be subject to a protracted debate about whether the right to raise subject-matter jurisdiction at any time incorporates the right to challenge the Court’s constitutional authority at any time. Pending litigation will certainly be subject to Stern v. Marshall; several bankruptcy courts have already raised the issue sua sponte or through requests for supplemental briefing.

Before Filing a Proof of Claim

There has been some debate as to whether a creditor waives its Article III rights by filing a proof of claim against a bankruptcy estate. As Stern put it, “Creditors who possess claims that do not satisfy the requirements for nondischargeability under 11 U.S.C. § 523 have no choice but to file their claims in bankruptcy proceedings if they want to pursue the claims at all. That is why ... the notion of ‘consent’ does not apply in bankruptcy proceedings as it might in other contexts.”[13] From this, it would seem illogical to require a creditor to waive its constitutional rights in order to obtain a fair share of a discharged debtor’s assets.

Also, before filing a proof of claim in bankruptcy court, creditors should evaluate the likelihood of a debtor’s counterclaim and consider whether or not the bankruptcy court will have constitutional authority to adjudicate it, or if instead it will give rise to state or federal district court litigation. Waging war over which court may or should hear the case will favor those creditors with deep pockets and strong preferences for particular forums, but in many cases settlement may be the more attractive option.

Getting Out of Bankruptcy Court: Litigation Strategies

Broadly, creditors attempting to remove a case from bankruptcy court should focus on whether the particular claim at issue is founded primarily on state law, and whether the creditor has the right to a jury trial. More specifically, the constitutional overlay made visible in Stern adds a level of complexity to what used to be a fairly straightforward jurisdictional inquiry. In effect, Stern may have created a class of controversies that are “core” but for which the bankruptcy court lacks the constitutional mandate to determine.[14] Accordingly, it may now be possible to pull even a “core” claim out of bankruptcy court. And if a non-core claim is before the bankruptcy court, a creditor could also risk consenting to the bankruptcy court’s authority and then challenge the constitutionality of that authority if the outcome proves unfavorable.

Getting into Bankruptcy Court: Intercreditor Disputes

At the most fundamental level, a bankruptcy court lacks jurisdiction over an intercreditor dispute in which such dispute does not “arise under,” “arise in,” or is not “related to” the bankruptcy case. This concept has been complicated by Stern, which narrowed the ability of a bankruptcy court to resolve certain matters directly affecting the administration of estate assets. While it remains to be seen whether the Stern decision will bear upon the framework previously employed by bankruptcy courts in the intercreditor context, Stern may impair the authority of a bankruptcy court to issue final decisions with respect to intercreditor disputes that have previously been deemed core.

Confirmed Plans

Provisions of plans containing grants of exclusive broad post-confirmation jurisdiction to the bankruptcy court may no longer be enforceable. This might have the effect of delaying confirmation of a plan and increase leverage by creditors hoping to obtain a more favorable settlement. 

Conclusion
For decades, the Bankruptcy Amendments and Federal Judgeship Act of 1984 had been a bright light in the otherwise murky world of bankruptcy court jurisdiction. Through the Act, Congress established a jurisdictional framework allowing bankruptcy judges to enter final judgments in “core” proceedings arising under title 11 or arising in a case under title 11, and, if lacking the consent of the parties, to submit proposed findings of fact and conclusions of law to the district court in so-called “non-core” proceedings that are related to a case under title 11. These basic principles informed our collective understanding of bankruptcy court authority until Stern’s arrival more than 25 years later. 

Now, as the landscape darkens and hopes of a second succor from Congress grow dim, the burden of fashioning order from chaos falls to the courts. For judges facing a rising tide of litigants eager to test the boundaries of bankruptcy court jurisdiction, Stern offers remarkably little in the way of guidance. And as long as Stern’s message eludes certainty and escapes consensus, the frustration emanating from many newly minted court opinions will be shared by bankruptcy practitioners and their clients for years to come.