Bankruptcy Litigation Committee

ABI Committee News

 

Ninth Circuit “Stern” Decision Creates a Circuit Split on Issues of Article III Waiver and the Statutory Gap

In the wake of the U.S. Supreme Court’s opinion in Stern v. Marshall[1] federal courts have issued differing opinions regarding the scope of a bankruptcy court’s jurisdiction to enter final judgments in adversary proceedings. In Executive Benefits Insurance Agency v. Arkison[2], the Ninth Circuit Court of Appeals weighed in to interpret Stern and held that a bankruptcy court may not enter a final judgment on a claim to avoid a fraudulent conveyance against a noncreditor to a bankruptcy estate.

The facts underlying the Executive Benefits decision are typical of a fraudulent conveyance claim: An insolvent debtor transfers assets (in this case, insurance commissions) to a recently formed company and later files for bankruptcy. In the bankruptcy case, the chapter 7 trustee sued the transferee entity (a noncreditor) for, among other things, federal and state law preference and fraudulent transfer claims in order to recover the insurance commissions. In granting the trustee’s motion for summary judgment, the bankruptcy court found the transfers to be fraudulent and entered a final judgment for $373,291.28. After the district court, on appeal, affirmed the bankruptcy court’s decision, the appellant-transferee appealed to the Ninth Circuit, contesting for the first time the bankruptcy court’s authority to enter a final judgment under Stern.

On appeal, after determining that fraudulent conveyance claims do not fall within the public right exception discussed in Stern andin Granfinciera S.A. v. Nordberg[3] the Ninth Circuit addressed the argument raised by several amici that bankruptcy courts can render final judgments on fraudulent transfer claims arising under the Bankruptcy Code, as distinguished from fraudulent transfers arising under state law. The Ninth Circuit rejected this argument, relying upon Stern and Granfinciera, holding that the Stern court’s characterization of the holding in Granfinanciera would render Stern internally contradictory if a blanket “public right” classification applied for any claim based on federal law.

The Ninth Circuit also acknowledged that its decision created a gap in the statutory framework governing the jurisdiction of the bankruptcy courts. Specifically, although federal law authorizes bankruptcy judges to “hear and determine all cases under title 11 and all core proceedings arising under title 11,”[4] the Constitution prohibits bankruptcy judges from entering a final judgment in core proceedings when the primary cause of action is not against a creditor to the estate.

The Ninth Circuit, having found an absence of authority for a bankruptcy court to enter a final judgment against a noncreditor on a fraudulent transfer claim, also held that § 157 permits bankruptcy courts to submit reports and recommendations to the district courts in core proceedings. The court acknowledged that this finding created a split with the Sixth Circuit, which previously held, in dicta, that bankruptcy courts cannot propose findings of facts and conclusions of law in core proceedings.[5]

Although the Ninth Circuit found that a bankruptcy court lacked the authority to enter a final judgment in such a case, it nevertheless affirmed the district court’s opinion, holding that the defendant waived its right to an Article III hearing by litigating in the bankruptcy court without having raised any objection to that court’s jurisdiction to hear the fraudulent transfer claim. Interestingly, this holding also contradicts the Sixth Court’s Waldman opinion, in which the Court of Appeals found that a party could not waive its Article III rights.[6]

Implications
Since the Supreme Court issued its opinion in Stern in June 2011, numerous bankruptcy courts, legal communities and scholars have weighed in on the impact and implications of the Stern opinion. As aptly demonstrated by Executive Benefits, litigants must be aware of how their circuit is interpreting Stern so not to step on any proverbial Stern landmines.

In the Ninth Circuit, following Executive Benefits, a bankruptcy court’s constitutional authority may not extend to entering judgment on fraudulent transfer claims against a noncreditor. Plaintiffs asserting fraudulent transfer claims in bankruptcy should either (a) bring their claims in the first instance before the district court or (b) request that the bankruptcy court propose findings of fact and conclusions of law, rather than enter a final judgment. Likewise, defendants in all jurisdictions should be careful not to waive any Article III objections.

These strategy decisions are of particular concern to plaintiffs who may benefit from asserting fraudulent transfer claims before the bankruptcy courts, which routinely hear such claims and will be familiar with the facts of the underlying bankruptcy case. In light of Stern, Executive Benefits and their progeny, a plaintiff will need to weigh the convenience of bringing such litigation before a bankruptcy court against the procedural issues that may arise because the bankruptcy court cannot issue the final judgment on such claims.

 

1. 131 S.Ct. 2594 (2011)

2. In re Bellingham Insurance Agency, No. 11-35162, 2012 WL 6013836 (9th Cir. Dec. 4, 2012)

3. 492 U.S. 33 (1989)

4. 28 U.S.C. § 157(b)(1)

5. Waldman v. Stone, 698 F.3d 910, 921 (6th Cir. 2012) (observing in dicta that bankruptcy courts may “enter” orders and judgments and not propose findings of fact and conclusions of law in “core” proceedings)

6. See Waldman 698 F.3d at 918.