August 21, 2012 Articles

A Survey of Cases Interpreting Stern v. Marshall, Part III

The number of sources citing Stern exceeded the 1,000 mark in early July 2012.

By Omar J. Alaniz

The number of sources citing Stern exceeded the 1,000 mark in early July 2012. This article refers to a chart that catalogues all cases that have meaningfully discussed Stern from September 1, 2011, through July 15, 2012. The author wishes to thank Evan R. Baker of Gardere Wynne Sewell LLP for his contribution to the chart.

Subject Matter Jurisdiction
As the bankruptcy court aptly noted in Empire State Building Co. L.L.C. v. N.Y. Skyline, Inc. (In re N.Y. Skyline, Inc.), 471 B.R. 69 (Bankr. S.D.N.Y. 2012), “Stern did not concern the subject matter jurisdiction of the bankruptcy court, but rather, the allocation of the authority as between the district court and the bankruptcy court to enter final judgments.” See also Ace Am. Ins. Co. v. DPH Holdings Corp. (In re DPH Holdings Corp.), 448 F. App’x. 134, 136 (2d Cir. 2011); Part I at 2–3; Part II at 4–5.

 

But in Cilio v. Wezner (In re Wezner), 470 B.R. 344 (Bankr. E.D. Pa. 2012), the bankruptcy court dismissed various state law causes of action for lack of subject matter jurisdiction because the debtor’s claims, if successful, would augment the estate. The author respectfully disagrees with this decision based on 28 U.S.C. §§ 1334(b) and 157(a). The bankruptcy court had jurisdiction over the state law claims under its “related to” jurisdiction. True, the bankruptcy court would not be able to enter a final order on those state law claims, not because of Stern but because section 157(b)(1) does not allocate “related to” matters to the bankruptcy court for final adjudication. Instead, the bankruptcy court could have submitted proposed findings of fact and conclusions of law under section 157(c)(1) or entered a final order on the claims with the parties’ consent under section 157(c)(2). Under either scenario, dismissal of the state law claims in Wezner was inconsistent with the jurisdiction and allocation scheme of sections 1334 and 157.

 

Adversary Proceedings—Avoidance Actions

Courts continue to differ on whether a bankruptcy court may enter a final order in avoidance actions. Generally, the split between the courts can be divided into an expansive and a narrow view. See Part I at 3–5; Part II at 6–7. If a court does not take an affirmative position on the issue—for example, merely denies a motion to dismiss the action—the decision is designated as “Neutral” in the accompanying chart.

 

Expansive View
The district courts in the Southern District of New York continue to be the leaders of the expansive view of Stern, that a bankruptcy court does not have the constitutional authority to enter final orders in avoidance actions. See, e.g., Penson Fin. Serv., Inc. v. O’Connell (In re Arbco Capital Mgmt., LLP), ___ F. Supp. 2d ___, 2012 WL 2852619 (S.D.N.Y. July 12, 2012) (fraudulent transfer and preference actions); Kirschner v. Agoglia, ___ F. Supp. 2d ___, No. 11 Civ. 8250, 2012 WL 1622496 (S.D.N.Y. May 9, 2012) (fraudulent transfer actions); Weisfelner v. Blavatnik (In re Lyondell Chem. Co.), 467 B.R. 712 (S.D.N.Y. 2012) (same); Messer v. Bentley Manhattan Inc. (In re Madison Bentley Assocs., LLC), Adv. No. 10-03487, 2012 WL 2434764 (S.D.N.Y. June 26, 2012) (same). See also Part I at 4; Part II at 6.

 

The notable exception to the Southern District of New York district courts’ adoption of the expansive view is found in footnote 5 of Marshall v. Picard (In re Madoff), ___ F. Supp. 2d ___, No. 10 Civ. 4652, 2012 WL 990829, at *12 n.5 (S.D.N.Y. Mar. 26, 2012). In that case, the district court opined that Stern cannot be reasonably interpreted as holding that the power explicitly accorded by Congress to the bankruptcy courts to enter judgment in fraudulent transfer actions violates Article III.

 

The arguments supporting the expansive view have not changed much. See Part I at 4, 12–13; Part II at 6. In Kirschner v. Agoglia, the district court determined that a conclusion that a fraudulent transfer claim—the very claim presented in Granfinanciera—is a “public right” would be totally at odds with the Stern Court’s analogy to Granfinanciera. The district court further noted that cautionary dicta in Stern and past practice do not overcome the logic of the Supreme Court’s holding in Stern. The court opined that simple logic dictates, unequivocally, that fraudulent conveyance claims are “private rights,” which, under Stern and the Constitution, must be finally tried by an Article III court. See also Penson, 2012 WL 2852619, at *7–9.

 

During the period from March 15 through July 15, the expansive view also was adopted in Ivey v. Vester (In re Whitley), Adv. No. 11-2056, 2012 WL 1268220 (Bankr. M.D.N.C. Apr. 13, 2012); Burns v. Dennis (In re Southeastern Materials, Inc.), 467 B.R. 337 (Bankr. M.D.N.C. 2012); and Lain v. Erickson (In re Erickson Retirement Community LLC), Civ. No. WDQ-11-3736, 2012 WL 1999493 (D. Md. June 1, 2011).

 

Narrow View
The leaders of the narrow view, that the bankruptcy court does have constitutional authority to enter a final order in avoidance actions, are Texas courts and bankruptcy courts within the Third Circuit. The decisions issued by these courts during the period from March 15 through July 15 include Zazzali v. 1031 Exchange Group (In re DBSI, Inc.), 467 B.R. 767 (Bankr. D. Del. 2012); Feuerbacher v. Moser, Case No. 4:11-cv-272, 2012 WL 1070138 (E.D. Tex. Mar. 29, 2012); Cadle Co. v. Brunswick Homes, LLC (In re Moore), 470 B.R. 414 (Bankr. N.D. Tex. 2012); Chow v. Prince (In re Prince), Adv. No. 10-4214, 2012 WL 1095506 (Bankr. E.D. Tex. Mar. 30, 2012); Post-Confirmation Committee v. Tomball Forest, Ltd. (In re Bison Building Holdings, Inc.), Adv. No. 11-3339, 2012 WL 1758232 (Bankr. S.D. Tex. May 14, 2012) (preference action).

 

In Feuerbacher v. Moser, the district court reasoned that the trustee’s fraudulent transfer claims under sections 544(b) and 548 of the Bankruptcy Code flowed directly from a federal statutory scheme. The court cited to a Second Circuit opinion holding that fraudulent conveyance actions are inextricably tied to the creation of the estate in bankruptcy for the benefit of the debtor’s creditors. See Feuerbacher, 2012 WL 1070138, at *6 (citing In re Kaiser, 722 F.2d 1574, 1582 (2d Cir. 1983)). The court also opined that adjudication of a fraudulent conveyance action in the bankruptcy context is a particularized area of law that is a core aspect of administration of the estate. Further, this administration is “tied to, if not solely based on, the bankruptcy courts’ ‘principally in rem jurisdiction.’” See id. at *7 (citing In re Refco, Inc., 461 B.R. 181, 184 (Bankr. S.D.N.Y. 2011) (quoting Cent. Va. Cmty. Coll. v. Katz, 546 U.S. 356 (2006)). However, the district court in the Refco case disagreed with the bankruptcy court’s adoption of the narrow view. Nevertheless, the district court in Feuerbacher v. Moser discusses its disagreement with the courts adopting the expansive view. See 2012 WL 1070138, at *8.

 

Other cases supporting the narrow view in the period from March 15 through July 15 include Sarachek v. Righ Place, Inc. (In re Agriprocessors, Inc.), Adv. No. 10-9123, 2012 WL 2872054 (Bankr. N.D. Iowa July 12, 2012); Marshall v. Picard (In re Madoff), ___ F. Supp. 2d ___, No. 10 Civ. 4652, 2012 WL 990829 (S.D.N.Y. Mar. 26, 2012); Official Committee of Unsecured Creditors of Appalachian Fuels, LLC v. Energy Coal Resources (In Appalachian Fuels, LLC), Case No. 0:11-CV-128, 2012 WL 1344984 (E.D. Ky. Apr. 18, 2012); Brooke Corp. v. Bank of New York Mellon (In re Brooke Corp.), Adv. No, 10-6245, 2012 WL 1759322 (Bankr. D. Kan. May 15, 2012); and Wadsworth v. DeLaFuente (In re DeLaFuente), Adv. No. 10-1911, 2012 WL 1535848 (Bankr. D. Colo. Apr. 30, 2012). See especially Samson v. W. Capital Partners (In re Blixseth), Adv. No. 10-00094, 2012 WL 1981719 (Bankr. D. Mont. June 1, 2012) (originally holding that bankruptcy courts did not have “jurisdiction” to hear fraudulent conveyance actions, then vacating that portion of the decision in 463 B.R. 896, and finally determining that bankruptcy courts do have constitutional authority to hear and determine section 548 actions).

 

More Expansive View versus Narrow View
In a case that was not an avoidance action proceeding, the bankruptcy court in Moyer v. Koloseik (In re Sutton), 470 B.R. 462 (Bankr. W.D. Mich. 2012), vigorously defended the expansive view in a lengthy discussion that includes references to Newton’s theory of gravity and Wile E. Coyote. See 470 B.R. at 468, 474 n.39. Equally as colorful, but at the opposite end of the spectrum, was the bankruptcy court’s report and recommendation in Manning v. Methodist Hospital, Inc. (In re Merrillville Surgery Center), ___ B.R. ___, 2012 WL 2627517 (Bankr. N.D. Ill. June 27, 2012). The bankruptcy court expressed its staunch support for the narrow view and also stated that it would respectfully decline to perform a “magistrate judgelike role” in the event the district court denies withdrawal of the reference solely for pretrial matters. See id. at *6. Manning is discussed below under the heading “Submission of Proposing Findings of Fact and Conclusions of Law in the ‘Statutory Gap.’”

 

Adversary Proceedings—Non-Avoidance Actions
An adversary proceeding may contain a variety of causes of action based on federal law, state law, or both. In some adversary proceedings, a court may determine that the bankruptcy court has the statutory and constitutional authority to determine certain claims while it may lack the requisite authority with respect to other claims in the proceeding. See, e.g., Burns v. Dennis (In re Southeastern Materials, Inc.), 467 B.R. 337 (Bankr. M.D.N.C. 2012).

 

Asking the First Question
The question of whether a bankruptcy court has the authority to enter a final order on a particular claim should begin with an analysis of 28 U.S.C. §§ 1334(b) and 157. After determining jurisdiction under section 1334(b), the first question is whether section 157(b)(1) allocates power to the bankruptcy court to enter a final order on the matter. If the answer is yes, then a court must determine whether Congress constitutionally allocated such authority. This is the same logical sequence followed in Parts II and III of the Stern opinion.

 

In Parks v. Consumer Law Associates, LLC (In re Lewis), Adv. No. 10-5098, 2012 WL 1073126 (Bankr. D. Kan. Mar. 29, 2012), the bankruptcy court determined that it did not have constitutional authority to determine state law claims for accounting, turnover, unconscionable acts, and disgorgement of fees. The bankruptcy court reasoned that these claims involved adjudication of private rights and were not intrinsic to the bankruptcy process. See id. at *2. But were the first question asked, the discussion of whether the actions involved private rights would have been unnecessary. The claims in the proceeding were not core proceedings because they did not “arise under” title 11 and did “arise in” a title 11 case. In other words, section 157(b)(1) did not allocate to the bankruptcy court the power to hear and determine those matters. Rather, the claims were “related to” the title 11 case; therefore, the bankruptcy court’s authority was limited to submitting proposed findings of fact and conclusions of law under section 157(c)(1) (absent, of course, consent).

 

In Harris v. Pyramid GOM, Inc. (In re Capco Energy, Inc.), Adv. No. 10-3349, 2012 WL 1853471 (Bankr. S.D. Tex. May 18, 2012), the bankruptcy court determined that it did not have constitutional authority to enter a final judgment in an adversary proceeding regarding guarantees executed in connection with a purchase and sale agreement under a Chapter 11 plan. But perhaps the result would have been different were the first question asked. Again, the first question is whether section 157(b)(1) allocates power to the bankruptcy court to enter a final order on the matter.

 

Under section 157(b)(1), the bankruptcy court has the authority to enter final orders on matters “arising under” title 11 and “arising in” a title case. The dispute over the guarantees executed in connection with the purchase agreement under the Chapter 11 plan in Capco Energy was arguably a matter “arising in” a title 11 case. If the response is that the cause of action was premised under state law, the author respectfully believes that this response alone is insufficient. “Arising in” has to mean something more than matters arising under the Bankruptcy Code. Otherwise, the “arising in” language in section 157(b)(1) is superfluous. Perhaps one could argue that “arising in” means federal law that is not arising under title 11. But that argument would be specious. Take, for example, professional malpractice claims in bankruptcy cases. There is ample authority that a professional malpractice claim premised on state law but based on the professional’s representation of a bankruptcy estate is a matter “arising in” a title 11 case. See, e.g., Southmark Corp. v. Coopers & Lybrand (In re Southmark Corp.), 163 F.3d 925 (5th Cir. 1999); see also McClelland v. Grubbs & Ellis Valuation & Advisory Grp. (In re McClelland), 460 B.R. 397 (Bankr. S.D.N.Y. 2011) (addressing Stern and determining that removed state law action regarding professional negligence that allegedly occurred in connection with bankruptcy case was a core proceeding).

 

To be fair, the bankruptcy court in Capco Energy may have considered and determined that the matter did not fall under the ambit of “arising in,” though not addressing that issue in the opinion. Alternatively, one could argue that even if the matter did “arise in” a title 11 case (which answers only the first question), the answer to the second question is that Congress improperly allocated “arising in” matters to the bankruptcy court. See Part II at 5 (discussing and commenting on Ortiz v. Aurora Health Care, Inc. (In re Ortiz), 665 F.3d 906 (7th Cir. 2011)). In any event, the contours of “arising in” are best left for a more thoroughly researched article on the issue.

 

Other Adversary Proceeding Issues
In Joyner v. Liprie (In re Liprie), Adv No. 11-02003, 2012 WL 1144614 (Bankr. W.D. La. Apr. 4, 2012), the plaintiff challenged the bankruptcy court’s jurisdiction over state law claims or state law issues under Stern. The bankruptcy court held that it would not read Stern so broadly as to preclude it from addressing core matters merely because the bankruptcy court would be required to address questions of state law. See id. at *3. To the extent that claims were non-core matters, the bankruptcy court could submit proposed findings of facts and conclusions of law on those matters. See id.; see also 28 U.S.C. §157(c)(1). Similarly, in Olivie Development Group LLC v. Ki Chang Park, No. C11-1691Z, 2012 WL 1536207 (W.D. Wash. Apr. 30, 2012), the district court determined that the bankruptcy court had the constitutional authority to enter a final order on the determination of property of the estate even though the determination required the bankruptcy judge to interpret state law.

 

Other decisions addressing Stern in non-avoidance action adversary proceedings included Rentas v. Claudio (In re Garcia), Adv. No. 10-00170, 2012 WL 1021449 (Bankr. D.P.R. Mar. 26, 2012) (holding that turnover proceedings invoke the bankruptcy court’s most basic equitable powers to gather and manage the property of the estate), and Shaia v. Taylor (In re Connelly), Adv. No. 11-03315, 2012 WL 1098431 (Bankr. E.D. Va. Mar. 30, 2012) (holding that the bankruptcy court had constitutional authority over turnover action under section 542(c) because it arises under title 11).

 

Only a few opinions in adversary proceedings decided between March 15 and July 15 were truly “Stern cases.” In McElwee v. Scarff Brothers, Inc. (In re McElwee), 469 B.R. 566 (Bankr. M.D. Pa. 2012), the debtor objected to a creditor’s proof of claim and asserted a counterclaim. This is classically Stern (although the creditor’s claim in Stern was decided well before the counterclaim at issue). However, under the test adopted by the Stern court—that is, does the counterclaim stem from the bankruptcy itself or is resolution of the counterclaim necessary for resolution of the proof of claim—the bankruptcy court determined that it had constitutional authority to decide the counterclaim because the claim and counterclaim were inextricably intertwined both factually and legally.

 

But in Pacific International Grout Co. v. Pacific International Grout Co. (In re Zinkova), No. C12-778, 2012 WL 1865701 (W.D. Wash. May 21, 2012), the district court reached the opposite result in applying the Stern test. In Zinkova, the district court withdrew the reference after determining that a dischargeability action also involved state law counterclaims that were in no way derived from or dependent on bankruptcy law. But not all district courts will withdraw the reference even in adversary proceedings involving claims based entirely on state law. See infra “Submission of Proposing Findings of Fact and Conclusions of Law in the ‘Statutory Gap.’” For example, in Sergent v. McKinstry, Civ. No. 11-129, 2012 WL 967056 (E.D. Ky. Mar. 12, 2012), the district court determined that the bankruptcy court did not have constitutional authority to decide the estate’s counterclaims for breach of fiduciary duty, gross negligence/willful misconduct, and mismanagement, because ruling on the defendant’s proofs of claim would not necessarily resolve the counterclaims. Nevertheless, the district court determined that withdrawal of the reference was premature even though the movant had a jury trial right.

 

Consent
There has yet to be a case in which a court has concluded that, after Stern, parties are no longer permitted to consent to a bankruptcy court hearing and determine non-core matters. But several courts have concluded the opposite. During the period of March 15 through July 15, those cases include Miller v. Grosso (In re Miller), 467 B.R. 677 (Bankr. D. Mass. 2012); Stewart v. JPMorgan Chase Bank, N.A. (In re Stewart), ___ B.R. ___, Adv. No. 10-2654, 2012 WL 1850627 (Bankr. W.D. Pa. May 21, 2012); Falck Properties, LLC v. Parkvale Financial Corp. (In re Brownsville Property Corp., Inc.), 469 B.R. 216 (Bankr. W.D. Pa. 2012); Ryckman v. Ryckman, 468 B.R. 754 (Bankr. W.D. Pa. 2012); Ardi Ltd. Partnership v. River Entertainment Co. (In re River Entertainment Co.), 467 B.R. 808 (Bankr. W.D. Pa. 2012).

 

The River Entertainment decision contains the most thorough discussion of the consent issue. See 467 B.R. at 816–818. The case involved a conversion action that was removed from state court. During the initial eight months following removal, the plaintiff made statements in its pleadings and on the record that the bankruptcy court construed as the plaintiff’s implied consent to bankruptcy court adjudication. See id. at 824. Following Stern, the plaintiff challenged the bankruptcy court’s constitutional authority to enter a final judgment on its claims and the defendant’s counterclaims. See id. at 816.

 

The bankruptcy court in River Entertainment ultimately determined that the decision in Stern did not alter a bankruptcy court’s ability to adjudicate non-core matters by party consent. The bankruptcy court cited to the Ninth Circuit’s en banc decision in Pacemaker, in which the circuit court determined that the magistrate consent statute (28 U.S.C. § 636(c)) was constitutional. See Pacemaker Diagnostic Clinic of Am., Inc. v. Instromedix, Inc., 725 F.2d 537 (9th Cir. 1984). The Ninth Circuit opined in Pacemaker that in determining whether parties are capable of consenting to final adjudication of a case by a non-Article III tribunal, courts must consider the personal and structural protections of Article III. See id. at 541.

 

While the Supreme Court has consistently upheld a party’s ability to waive a “personal” right to have its matter heard by an Article III judge, the Court has also held that “structural” protections of Article III are beyond the ability of an individual to waive. See River Entm’t, 467 B.R. at 818–19 (citing Peretz v. United States, 501 U.S. 923, 936 (1991) and Commodity Futures Trading Comm’n v. Schor, 478 U.S. 833, 848 (1986)). Whether the structural protections of Article III are implicated depends on the degree of control exercised by Article III judges over the non-Article III tribunal. River Entm’t, 467 B.R. at 819 (citing Peretz, 501 U.S. at 937–39). The bankruptcy court in River Entertainment determined that Article III judges have sufficient control over bankruptcy courts such that the structural protections of Article III are not implicated by 28 U.S.C. § 157(c)(2).

 

The River Entertainment decision, however, raised an issue that has divided courts on consent. Some courts believe that consent cannot be implied by conduct in litigation, whereas other courts believe that consent can be implied. See Part II at 10. For instance, the bankruptcy court in River Entertainment noted that Stern stands for the proposition that consent can be implied through statements of a party and by a party’s delay in consenting to non-Article III adjudication. See Stern, 131 S. Ct. 2607–8. See also Ryckman v. Ryckman, 468 B.R. 754 (Bankr. W.D. Pa. 2012) (holding that commencing a dischargeability adversary proceeding and having neither requested relief from the stay or withdrawal of the reference constituted consent to bankruptcy court final adjudication of core and non-core matters involved in making the nondischargeability determination). Recall that the Court in Stern determined that Pierce had consented to the bankruptcy court’s adjudication of his defamation proof of claim (albeit not on Vickie’s tortious interference counterclaim). See also Shaia v. Taylor (In re Connelly), Adv. No. 11-03315, 2012 WL 1098431 (Bankr. E.D. Va. Mar. 30, 2012) (noting that Stern recognized that consent can be express or implied).

 

The River Entertainment opinion also cites the Supreme Court’s decision in Roell v. Withrow, 538 U.S. 580 (2003), in which the Court determined that a litigant’s consent to adjudication before a magistrate judge can be implied by its conduct in the litigation. But the district in Messer v. Bentley Manhattan Inc. (In re Madison Bentley Association., LLC), Adv. No. 10-03487, 2012 WL 2434764 (S.D.N.Y. June 26, 2012), did not agree that consent can be implied by conduct. That court stated that the “test for consent is strict” and that implied consent “appears to be insufficient.” See id. at *3. The district court cited to a 1987 Second Circuit opinion for support. See id. (citing Men’s Sportswear, Inc. v. Sasson Jeans, Inc. (In re Men’s Sportswear, Inc.), 834 F.2d 1134, 1138 (2d Cir. 1987)). But Men’s Sportswear was decided in 1987 well before Roell—though Roell addressed the magistrate consent statute in 28 U.S.C. § 636(c). The district courts in Penson and Lyondell point out, however, that under Federal Rule of Bankruptcy Procedure 7012, the bankruptcy court is permitted to enter final orders on non-core matters only “with the express consent of the parties.” (emphasis added). See Penson, 2012 WL 2852619, at *9; Lyondell, 467 B.R. at 722.

 

Contested Matters
The Stern decision has not caused consternation among courts vis-à-vis contested matters. During the period from March 15 through July 15, several courts determined that Stern did not prevent the bankruptcy court from issuing final orders in contested matters. See, e.g., In re USA Baby, Inc., 674 F.3d 882 (7th Cir. 2012) (motion to convert); In re SBMC Healthcare, LLC, Case No. 12-33299, 2012 WL 2308682 (Bankr. S.D. Tex. June 18, 2012) (application to employ professional); In re Airhart, No. 09-34070-H4, 2012 WL 1965609 (Bankr. S.D. Tex. May 31, 2012) (motion to redeem); Pusser’s (2001) Ltd. v. HMX, LLC, Case No. 11 C 4659, 2012 WL 1068756 (N.D. Ill. Mar. 28, 2012) (motion to sell property); S. Mont. Elec. Generation & Transmission Coop., Inc., No. 11-62031, 2012 WL 173922 (Bankr. D. Mont. May 15, 2012) (motion to modify stay); In re Sea Island Co., No 10-21034, 2012 WL 1499489 (Bankr. S.D. Ga. Apr. 10, 2012) (post-confirmation ruling on interpretation of liquidating trust agreement).

 

In Quigley Co. v. Law Offices of Peter G. Angelos (In re Quigley Co., Inc.), 676 F.3d 45 (2d Cir. 2012), the Second Circuit determined that the bankruptcy court had jurisdiction and constitutional authority to issue an injunction over asbestos-related suits pursuant to section 524(g). The Second Circuit wrote, “[w]hatever Stern’s precise contours (a matter we need not reach) we conclude that Stern has no application to the present case. The Supreme Court in Stern indicated that its holding was a narrow one.” See id. at 52.

 

In Ruth v. LVNV Funding, Inc. (In re Ruth), Adv. No. 10-03520, 2012 WL 1455814 (Bankr. S.D. Tex. 2012), the bankruptcy court determined it had constitutional authority to enter orders not only on claim allowance but also on a request for sanctions and damages award. The bankruptcy court reasoned that (i) Stern concerned only state law issues; (ii) the claims allowance process is expressly bankruptcy law, and state law has no equivalent; and (iii) resolution of the sanctions issues was necessary in determining the allowance of the proof of claim.

 

Dischargeability
Dischargeability actions present an interesting Stern question. Most would agree that the issue of whether a debt is dischargeable in bankruptcy is a core proceeding. This may be because the matter arises under title 11 (11 U.S.C. § 523) or arises in a title 11 case (i.e., dischargeability has no existence outside a bankruptcy case) and thus is a core proceeding under 28 U.S.C. § 157(b)(1). In addition, dischargeability also implicates a bankruptcy court’s in rem jurisdiction. See Cent. Va. Cmty. Coll. v. Katz, 546 U.S. 356, 362 (2006). But what if the creditor’s claim was not liquidated prior to the bankruptcy filing? Is it constitutionally permissible for the bankruptcy court to enter a final judgment on a non-core claim (e.g., a state law claim) and then determine whether that claim is dischargeable? The bankruptcy court in Farooqi v. Carroll (In re Carroll), 464 B.R. 293 (Bankr. N.D. Tex. 2011), answered in the affirmative, as discussed in Part II of this series. Other courts have followed suit since then.

 

In Deitz v. Ford (In re Deitz), 469 B.R. 11 (B.A.P. 9th Cir. 2012), the Ninth Circuit Bankruptcy Appellate Panel determined that the bankruptcy court had constitutional authority to determine a state law claim against the debtor because the matter arose in connection with a dischargeability action. The bankruptcy court had entered a money judgment in favor of the creditor and determined that the judgment was excepted from discharge under 11 U.S.C. § 523(a)(2)(A), (a)(4), and (a)(6). The debtor challenged the bankruptcy court’s constitutional authority to enter the money judgment. The Ninth Circuit Bankruptcy Appellate Panel determined that Stern did not overturn the Ninth Circuit’s precedent whereby it held that a bankruptcy court may enter a monetary judgment on a disputed state law fraud claim in the course of determining whether the debt was nondischargeable. See 469 B.R. at 21 (citing Cowen v. Kennedy (In re Kennedy), 108 F.3d 1015 (9th Cir. 1997)). Similarly, in Dulcetti v. Markwood Investments Ltd. (In re Neves), Case No. 11-24505, 2012 WL 1831717 (S.D. Fla. May 17, 2012), the district court determined that Stern does not undermine the federal circuit court decisions (citing the Fifth, Eighth, Ninth, and Tenth Circuits) that provide that bankruptcy courts do have authority to enter a money judgment in dischargeability proceedings. See also Aumaugher v. Apostle (In re Apostle), 467 B.R. 433 (Bankr. W.D. Mich. 2012); Williams v. Laughlin (In re Laughlin), Adv. No. 09-03451, 2012 WL 1014754 (Bankr. S.D. Tex. Mar. 23, 2012).

 

The Eighth Circuit Court of Appeals also struck down a Stern-type argument in a dischargeability appeal. See Pearson Educ., Inc. v. Almgren, ___ F.3d ___, 2012 WL 2865968 (8th Cir. July 13, 2012). In Pearson, creditors filed proofs of claim and an action to determine the claims nondischargeable. The creditors demanded a jury. The bankruptcy court ruled that the creditors waived their right to a jury when they filed proofs of claim, and the district court and Eighth Circuit affirmed. The courts cited Katchen v. Landy, 382 U.S. 323 (1966) and Langenkamp v. Culp, 498 U.S. 42 (1990), in which the Supreme Court held that a creditor that files a proof of claim waives its right to a jury trial in preference actions. The statutory basis underlying Katchen and Langenkamp is 11 U.S.C. § 502(d), but dischargeability actions (section 523) are not listed in section 502(d). Nevertheless, the Eighth Circuit cited other circuit decisions in which the circuits held that a bankruptcy court was permitted to enter a money judgment in connection with a dischargeability action. The Eighth Circuit opined that the creditors could not explain why “nondischargeability is any less ‘integral to the restructuring of the debtor-creditor relationship’ than the preference action at issue in Langenkamp.” See 2012 WL 2865968, at *2 (citing Langenkamp, 498 U.S. at 44).

 

“Statutory Gap”
A year after Stern, the concern about whether there is a “statutory gap” or a third category of proceedings that are “core but unconstitutional” appears to have been more bark than bite. The concern is that if a proceeding is “core” under section 157(b) and yet the bankruptcy court is somehow not constitutionally permitted to determine the matter, then section 157(c)(1) does not appear to supply the bankruptcy court with the authority to submit proposed findings of fact and conclusions of law because the statute refers only to non-core matters. This concern has been universally rejected in every case decided after September 2011. See Part I at 8–9; Part II at 12–13; see also Fort v. SunTrust Bank (In re Int’l Payment Grp., Inc.), No. 7:11-3363, 2012 WL 1107840 (S.D.S.C. Apr. 2, 2012) (collecting cases); Official Comm. of Unsecured Creditors v. Nat’l Patent Dev. Corp. (In re TMG Liquidating Co.), No. 7:12-629-TMC, 2012 WL 1986526 (D.S.C. June 4, 2012) (same).

 

The district court in Kirschner v. Agoglia provided a well-reasoned analysis of the statutory gap issue. As discussed above, that court determined that the bankruptcy court did not have constitutional authority to enter final orders in a fraudulent conveyance action. See 2012 WL 1622496 (S.D.N.Y. May 9, 2012). But that court also determined that the bankruptcy court could hear the matter and submit proposed findings of fact and conclusions of law despite the plain language of section 157(c)(1). The district court explained that section 157(c)(1) was enacted prior to Stern. Moreover, legislative permission is not needed for the report and recommendation process as district courts frequently refer matters to magistrate judges and special masters. In addition, the United States District Court for the Southern District of New York amended its Standing Order of Reference to permit the bankruptcy court to submit findings of fact and conclusions of law in statutorily core matters. See Bankr. S.D.N.Y. Local R. 9033-1. The district court held that the amended standing order of reference was well within the inherent power of a federal district court. See also Zazzali v. 1031 Exch. Grp. (In re DBSI, Inc.), 467 B.R. 767 (Bankr. D. Del. 2012) (discussing Delaware’s amended standing order of reference).

 

The statutory gap is addressed in a number of cases in which litigants move to withdraw the reference based on a Stern-type argument. But the district courts continue to deny motions premised on Stern-like arguments even for matters that are clearly non-core and where the movant has asserted (or has the right to assert) a jury demand. For the period discussed in this article, these cases include Renascent, Inc. Countrywide Home Loans, Inc. (In re Renascent, Inc.), Adv. No. 11-00045, 2012 WL 2050231 (D. Mont. May 31, 2012) (denying withdrawal on state law claims); Wells Fargo Bank v. Madan (In re AJ Town Centre, L.L.C.), No. 11-2061, 2012 WL 1106747 (D. Ariz. Apr. 2, 2012) (same); Sergent v. McKinstry, Civ. No. 11-129, 2012 WL 967056 (E.D. Ky. Mar. 12, 2012) (same); Schaefer v. Nextiraone Federal, LLC, Adv. No. 11-02076, 2012 WL 2281828 (M.D.N.C. June 18, 2012) (denying withdrawal on state law claims and despite anticipated jury trial demand); Joe Gibson’s Auto World, Inc. v. Zurich American Insurance Co. & Universal Underwriters Insurance Co. (In re Joe Gibson’s Auto World, Inc.), No. 7:11-2482, 2012 WL 1107763 (D.S.C. Apr. 2, 2012) (same); Mukamal v. KBC Fin. Prods. (Cayman Islands) Ltd., No. 12-80269, 2012 WL 2504009 (S.D. Fla. June 28, 2012) (denying withdrawal in fraudulent conveyance action); Messer v. Bentley Manhattan Inc. (In re Madison Bentley Associates, LLC), Adv. No. 10-03487, 2012 WL 2434764 (S.D.N.Y. June 26, 2012) (denying withdrawal even though court determined that the bankruptcy court would not have the constitutional authority to determine fraudulent conveyance or alter ego claims). But see Keybank Nat’l Ass’n. v. Huntington Nat’l Bank (In re Schwab Indus.), No. 5:11-MC-00107, 2012 WL 910069 (N.D. Ohio Mar. 16, 2012) (withdrawing the reference on breach of trust action because the claim arose under state law and did not derive from the bankruptcy claims adjudication process). The district courts in these cases held that the bankruptcy court is permitted to enter pretrial orders and to submit proposed findings of fact and conclusions of law.

 

The bankruptcy court in Manning v. Methodist Hospital, Inc. (In re Merrillville Surgery Center), disagreed with the district courts’ practice of partial withdrawal of the reference. See 2012 WL 2627517, at *5–6. In Manning, the trustee filed preference and fraudulent transfer actions against defendants who did not file a proof of claim and demanded a jury. The defendants moved to withdraw the reference, and the trustee objected, asserting, among other things, that at a minimum, the bankruptcy court is permitted to enter pretrial orders—leaving final disposition of the case with the district court. The bankruptcy court expressed that it would respectfully decline to perform a “magistrate judgelike role” in the event of a partial withdrawal of the reference. See id. at *6. The bankruptcy court reasoned that 28 U.S.C. § 151 states that bankruptcy judges are a “unit” of the district court, not an adjunct of the district court. See id. at *5; see also Stern, 131 S. Ct. at 2618–19. Thus, the bankruptcy court in Manning determined that a bankruptcy court is a separately administered court and not a court that serves a function similar to that of the magistrate court. See id.

 

For a more detailed discussion of jury right issues after Stern, see Part II.

 

Keywords: litigation, bankruptcy, Stern, jurisdiction, core, consent, jury, dischargeability, gap, constitutional authority


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