Bankruptcy Courts and the Constitution

Constitutional authority begins with the Constitution itself. The Constitution vests the federal judicial power in Article III courts. Article III judges are distinguished by two characteristics: they hold their offices during good behavior and receive compensation that will not be diminished while in office. Bankruptcy judges are not Article III judges. The authority to establish bankruptcy courts is instead found in Article I of the Constitution, which gives Congress the power “[t]o establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.”

Today, the Bankruptcy Code, found in title 11 of the United States Code, contains nearly all the applicable uniform federal bankruptcy law. But district courts, not bankruptcy courts, have original and exclusive jurisdiction of all cases under title 11. District courts have the option, however, to provide that those cases will be referred to the bankruptcy judges for their districts. District courts also have the option to refer proceedings to the bankruptcy judges for their districts if the proceedings fit into one of three categories: (1) arising under title 11, (2) arising in a case under title 11, or (3) related to a case under title 11. If the proceedings fit into one of the first two categories, they are “core” proceedings; therefore, bankruptcy judges may hear and determine them. But if the proceedings are only related to a case under title 11, bankruptcy judges are limited to hearing them and submitting proposed findings of fact and conclusions of law to the district court.

Sometimes there are challenges as to whether Congress has passed a law that exceeds its constitutional authority. These challenges may arise in the bankruptcy context. One recent example is a challenge to a bankruptcy judge’s authority under 28 U.S.C. § 157(b)(2)(C). That provision provides bankruptcy judges with authority to hear and determine “counterclaims by the estate against persons filing claims against the estate” because they are—as described above—“core” proceedings. In Stern v. Marshall, the Supreme Court of the United States addressed this provision. In that case, Vickie Lynn Marshall filed for bankruptcy, her deceased husband’s son filed a claim against her, and then she filed a counterclaim for tortious interference against him. Although the Supreme Court found that the bankruptcy court had statutory authority to hear and determine the claim, it held that the bankruptcy had no constitutional authority to do so. That constitutional authority, the Supreme Court held, belonged to Article III courts.

Restructuring of the Debtor-Creditor Relationship

The test for whether a bankruptcy judge has constitutional authority to hear and determine a proceeding is whether it is integral to the restructuring of the debtor-creditor relationship. Stern v. Marshall, 564 U.S. 462, 497 (2011) (“We explained [in Langenkamp] that a preferential transfer claim can be heard in bankruptcy when the allegedly favored creditor has filed a claim, because then ‘the ensuing preference action by the trustee become[s] integral to the restructuring of the debtor-creditor relationship.’” (citing Langenkamp v. Culp, 498 U.S. 42, 44 (1990) (per curiam)); Langenkamp, 498 U.S. at 44 (“In other words, the creditor’s claim and the ensuing preference action by the trustee become integral to the restructuring of the debtor-creditor relationship through the bankruptcy court’s equity jurisdiction. . . . As such, there is no Seventh Amendment right to a jury trial.” (citing Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 57–58 (1989)); Granfinanciera, 492 U.S. at 58–59 (“Because petitioners here, like the petitioner in Schoenthal, have not filed claims against the estate, respondent’s fraudulent conveyance action does not arise ‘as part of the process of allowance and disallowance of claims.’ Nor is that action integral to the restructuring of debtor-creditor relations. Congress therefore cannot divest petitioners of their Seventh Amendment right to a trial by jury.” (emphasis added)); N. Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 71 (1982) (plurality opinion) (“[T]he restructuring of debtor-creditor relations, which is at the core of the federal bankruptcy power, must be distinguished from the adjudication of state-created private rights, such as the right to recover contract damages that is at issue in this case.”).

Proceedings that are integral to the restructuring of the debtor-creditor relationship may be limited to proceedings to collect a debtor’s property, resolve claims by creditors, order the distribution of assets in the estate, and ultimately discharge the debts. This explanation is qualified by may be because the Supreme Court has yet to provide a complete list of proceedings that are integral to the restructuring of the debtor-creditor relationship. But this explanation is consistent with the Supreme Court’s decisions on the constitutional authority of bankruptcy courts (or bankruptcy referees in Katchen).

Integral to the Restructuring:

• In Katchen v. Landy, 382 U.S. 323 (1966), the Court held that a bankruptcy referee (similar to a bankruptcy court today) had constitutional authority to hear and determine a proceeding to resolve claims by creditors. The bankruptcy trustee brought a voidable preference claim against a creditor who had filed a proof of claim in the bankruptcy proceeding. The referee could not rule on the creditor’s proof of claim without first resolving the voidable preference issue.
• In Langenkamp v. Culp, 498 U.S. 42 (1990) (per curiam), the Court held that a bankruptcy court had constitutional authority to hear and determine a proceeding to resolve claims by creditors. The bankruptcy trustee brought a preferential transfer claim against an allegedly favored creditor who had filed a claim.

Not Integral to the Restructuring:

• In Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982) (plurality opinion), the Court held that a bankruptcy court could not hear and determine a reorganizing debtor’s suit against a third party seeking damages for alleged breaches of contract and warranty, as well as for alleged misrepresentation, coercion, and duress.
• In Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989), the Court held that a bankruptcy court could not hear and determine a fraudulent conveyance action filed by a bankruptcy trustee on behalf of a bankruptcy estate against a non-creditor.
• In Stern v. Marshall, 564 U.S. 462 (2011), the Court held that a bankruptcy court could not hear and determine a debtor’s counterclaim for tortious interference.

A recent dissent by Chief Justice John Roberts, the author of the majority opinion in Stern, provides another piece of the what-is-integral-to-the-restructuring puzzle. In Wellness International Network, Ltd. v. Sharif, 135 S. Ct. 1932 (2015), the Chief Justice dissented because the majority decided the case on broad grounds where narrower would have done. One paragraph of his opinion is key. He explains that the bankruptcy court’s constitutional authority to adjudicate is based on historical practice—specifically the practice when the founders drafted the Constitution in 1787. At that time, “English statutes had long empowered nonjudicial bankruptcy ‘commissioners’ to collect a debtor’s property, resolve claims by creditors, order the distribution of assets in the estate, and ultimately discharge the debts.” Wellness, 135 S. Ct. at 1951 (Roberts, C.J., dissenting) (citing 2 W. Blackstone, Commentaries *471–88).

This view of the constitutional authority of bankruptcy courts is also consistent with the Supreme Court’s view of the constitutional authority of Article III courts. Article III judges are responsible for deciding suits that are “made of ‘the stuff of the traditional actions at common law tried by the courts at Westminster in 1789,’ . . . and [are] brought within the bounds of federal jurisdiction.” Stern v. Marshall, 564 U.S. 462, 484 (2011) (citing N. Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 90 (1982) (Rehnquist, J., concurring in judgment)). In the same vein, bankruptcy judges would be responsible for deciding suits that are made of the stuff that English bankruptcy commissioners decided in 1789. But the Supreme Court has yet to decide how far the constitutional authority of bankruptcy courts to adjudicate might extend beyond the power that English bankruptcy commissioners had in 1789.

Consent to Adjudication

In Wellness International Network, Ltd. v. Sharif, 135 S. Ct. 1932 (2015), the Supreme Court held that a bankruptcy judge can adjudicate claims for which litigants are constitutionally entitled to adjudication by an Article III judge if one condition is met: the parties knowingly and voluntarily consent to adjudication by that bankruptcy judge. In other words, bankruptcy litigants can waive the right to Article III adjudication of Stern claims. Stern claims are those that the bankruptcy courts have statutory but not constitutional authority to hear and determine. In Wellness, the Supreme Court also emphasized that such consent need not be express; it can be implied. But such consent must still be knowing and voluntary.

Public Rights Doctrine

The Supreme Court first described the public rights doctrine in Murray’s Lessee v. Hoboken Land & Improvement Co., 59 U.S. 272 (1856). In essence, that doctrine provides non-Article III courts with a constitutional basis to resolve matters that involve public rights. Bankruptcy courts are non-Article III courts. The Supreme Court has addressed the application of the public rights doctrine in the bankruptcy context, but it has yet to hold that the public rights doctrine provides bankruptcy courts with constitutional authority to hear and determine proceedings. See Stern v. Marshall, 564 U.S. 462, 493 (2011) (“Vickie's counterclaim—like the fraudulent conveyance claim at issue in Granfinanciera—does not fall within any of the varied formulations of the public rights exception in this Court's cases.”); N. Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 71 (1982) (plurality opinion) (“Finally, the substantive legal rights at issue in the present action cannot be deemed ‘public rights.’”).

Nonconsensual Third-Party Releases in Chapter 11 Plans

Chapter 11 debtors sometimes file a plan of reorganization with third-party releases. These provisions may release the claims of creditors against third parties. If a creditor votes against the plan, the third-party releases are termed nonconsensual. The courts of appeals are split as to whether circumstances exist when a bankruptcy court may confirm a chapter 11 plan with nonconsensual third-party releases. See Collier Bankruptcy Practice Guide ¶ 84.02[1][c][v] (citing decisions from the First, Second, Fourth, Fifth, Sixth, Seventh, Ninth, Tenth, Eleventh, and D.C. circuits).

The Third Circuit recently addressed whether a bankruptcy court had constitutional authority to confirm a Chapter 11 plan with certain nonconsensual third-party releases. In In re Millennium Lab Holdings II, LLC, 945 F.3d 126 (3d Cir. 2019), the court held that the bankruptcy court had such authority.

In that case, Millennium provided laboratory-based diagnostic services. In 2015, the U.S. Department of Justice filed a complaint against Millennium, and then the Centers for Medicare and Medicaid Services notified Millennium that its Medicare privileges were being revoked. Millennium then reached an agreement in principle with the DOJ and CMS, but it did not have enough money to make the required settlement payment. Adding to its liquidity problems, Millennium had entered into a $1.825 billion credit agreement one year earlier.

To settle with the government, Millennium had to negotiate a transaction with its lenders. After negotiations, Millennium, its equity holders, and an ad hoc group of lenders entered into a restructuring support agreement. As part of the agreement, Millennium’s equity holders transferred 100% of the equity interests in Millennium to the company’s lenders. In exchange, some equity holders and various others received broad releases: the releases covered all claims arising from conduct before the agreement (including anything related to the above credit agreement).

After entering into the agreement, the parties failed to reorganize Millennium out of court. Next, Millennium filed its petition for bankruptcy. Millennium submitted a prepackaged plan of reorganization, which reflected the terms of the agreement. But a variety of funds and accounts, collectively referred to as Voya, objected to confirmation of the plan. Voya asserted it had significant legal claims against Millennium and its equity holders—claims that would be released by confirmation of the plan. In sum, Voya argued that the bankruptcy court lacked constitutional authority to confirm the plan with the specific releases. On appeal, the Third Circuit held that the bankruptcy court had constitutional authority to confirm the plan.

At first blush, the constitutional authority of a bankruptcy court in this context is difficult to determine. To begin with, the Supreme Court has provided few examples of what a bankruptcy court is authorized to determine under the Constitution. In Katchen, a bankruptcy referee (similar to a bankruptcy court today) could determine a proceeding in which a bankruptcy trustee brought a voidable preference claim against a creditor who had filed a claim. In Langenkamp, a bankruptcy court could determine a proceeding in which a bankruptcy trustee brought a preferential transfer claim against an allegedly favored creditor who had filed a claim. That’s about it. The Supreme Court has provided more examples of what the bankruptcy court is not constitutionally authorized to determine.

Relying on Supreme Court precedents, however, the Third Circuit in Millennium concluded that the bankruptcy court had constitutional authority to determine the proceeding at issue. And the court limited its holding to the “specific, exceptional facts of this case.” These are the specific, exceptional facts that the court identified:

• The released parties were not willing to make their contributions under the plan without the releases and the enforcement of such releases through the plan’s injunction provisions.
• Without the contributions of the released parties, the debtors would have been unable to satisfy their obligations under the settlement with the government, no chapter 11 plan would have been feasible, and the debtors likely would have shut down upon revocation of their Medicare enrollment and billing privileges.
• The record made abundantly clear that the release provisions were agreed to only after extensive, arm’s length negotiations.

The court found that, under these facts, the release provisions were integral to the restructuring of the creditor-debtor relationship. For that reason, the court concluded that the bankruptcy court had constitutional authority to confirm the chapter 11 plan with those releases.

On March 18, 2020, Voya filed a petition for a writ of certiorari. Voya argued that the Millennium decision has created a circuit split concerning the proper test for determining the scope of a bankruptcy court’s constitutional authority to enter final judgment under Stern. Voya also argued that recent decisions of the Supreme Court have undermined the legal basis for the equitable mootness doctrine. On May 26, 2020, the Supreme Court denied Voya’s petition.

Conclusion

A bankruptcy judge has constitutional authority to hear and determine a proceeding if it is integral to the restructuring of the debtor-creditor relationship. When the founders drafted the Constitution, empowering Congress to establish uniform laws on bankruptcy, the bankruptcy power in England was exercised by bankruptcy commissioners. In 1787, those bankruptcy commissioners collected a debtor’s property, resolved claims by creditors, ordered the distribution of assets in the estate, and ultimately discharged the debts. The Supreme Court has yet to explain how far the constitutional authority of bankruptcy courts to hear and determine proceedings might extend beyond proceedings of that kind. In Millennium, the Third Circuit recently held that—under specific, exceptional facts—a bankruptcy court had constitutional authority to confirm a chapter 11 plan with nonconsensual third-party releases.