March 13, 2013 Articles

A Survey of Cases Interpreting the Stern Decision, Part V

This fifth part in the series is a synthesis and discussion of the cases that have meaningfully discussed Stern from October 16, 2012, through January 15, 2013.

By Omar J. Alaniz

This article is the sixth in a multipart series that provides an overview of how courts across the nation are interpreting Stern v. Marshall, 131 S. Ct. 2594 (2011). Read Part I, Part II, Part III, and Part IV.

This fifth part in the series is a synthesis and discussion of the cases that have meaningfully discussed Stern from October 16, 2012, through January 15, 2013 (which is referred to as “this period”). However, the Sixth Circuit’s decision in Machine & Fabrication, LLC v. Stone (In re Waldman) was discussed in Part IV, and that analysis will not be repeated in this article. To avoid redundancy, this article includes citations to Parts I–IV of this article series, and it refers to a chart that catalogues all cases that have meaningfully discussed Stern in this period.

Fraudulent Transfer
The most significant case decided during this period was the much-anticipated Ninth Circuit decision in Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency, Inc.). The Ninth Circuit is the first circuit court to address the most divisive Stern issue: whether a bankruptcy court has the constitutional authority to enter a final order in fraudulent transfer actions when the defendant has not filed a proof of claim. The Sixth Circuit’s case of Onkyo Europe Electronics GMBH v. Global Technovations Inc. (In re Global Technovations Inc.) involved a fraudulent transfer action where the defendant had filed a proof of claim. Therefore, the Sixth Circuit’s decision in Global Technovations was not nearly as groundbreaking as the Ninth Circuit’s decision in Bellingham Insurance. See Part IV at 6; see also 4100 W. Grand LLC v. Ty Grand LLC (In re 4100 W. Grand LLC), B.R., Adv. No. 11-02278, 2012 WL 5177557 (Bankr. N.D. Ill. Oct. 12, 2012). The district court in the Madoff case recently held that the bankruptcy court lacked constitutional authority to enter a final order in avoidance actions under the Securities Investor Protection Act (SIPA) even though the defendants filed claims in the bankruptcy. Sec. Inv. Prot. Corp. v. Bernard L. Madoff Inv. LLC, No. 12 MC 115, 2013 WL 67605 (S.D.N.Y. Jan. 4, 2013). But the SIPA (unlike 11 U.S.C. sections 544 and 548) is not listed in section 502(d). Section 502(d) is what gives the bankruptcy court the power to rule on fraudulent transfer actions when the defendant has filed a proof of claim. See Part III at 10; Part IV at 6–7.

In Bellingham Insurance, the Ninth Circuit followed fairly closely the post-Stern arguments that lower courts have made supporting the expansive view of Stern. See Part I at 4, 12–13; Part II at 6; Part III at 3; Part IV at 5. The expansive view relies on Granfinanciera just as much—if not more than—as on Stern. The issue in Granfinanciera was whether the defendant was entitled to a jury in a fraudulent transfer action, but in reaching its holding, the Supreme Court determined that fraudulent transfer actions involve private (not public) rights. See Exec. Benefits Ins. Agency v. Arkison (In re Bellingham Ins. Agency, Inc.), F.3d, No. 11-35162, 2012 WL 6013836, at *6 (9th Cir. Dec. 4, 2012) (citing Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 55 (1989)). The Ninth Circuit reasoned that because Stern held that non-Article III courts cannot adjudicate private rights cases, the inevitable conclusion is that bankruptcy courts may not adjudicate fraudulent transfer actions when the defendant has not filed a proof of claim. See id. at *7–8. But as the Ninth Circuit cautioned, its decision was “no reprieve” for the defendant because the Ninth Circuit determined that the defendant implied consent to the bankruptcy court’s authority to rule on the matter (as discussed below).

The other cases supporting the expansive view during this period were Litigation Trust of The Rhodes Co., LLC v. Rhodes, Adv. No. 12-01099, 2012 WL 5456084 (D. Nev. Nov. 7, 2012) and Kriegman v. Cilwa (In re LLS Am., LLC), Adv. No. 11-80161, 2012 WL 5285654 (E.D. Wash. Oct. 25, 2012).

Three cases joined the narrow-view camp (see Part I at 4–5; Part II at 6–7; Part III at 3–4; Part IV at 5–6): Ward v. Jenkins (In re Jenkins), Adv. No. 12-5033, 2012 WL 6186347 (Bankr. W.D.N.C. Dec. 12, 21012); Cifelli v. Rame Prop., LLC (In re Miles), 481 B.R. 832 (Bankr. N.D. Ga. 2012); and Silverman v. A-Z RX LLC (In re Allou Distribs., Inc.), B.R., No. 04-08369, 2012 WL 6012149 (Bankr. E.D.N.Y. 2012). In Allou Distributions, the bankruptcy court reasoned that (1) a fraudulent transfer claim flows from the federal statutory scheme, (2) Northern Pipeline should be applied narrowly to traditional contract actions arising under state law and where the litigants do not consent to the final judgment of a non-Article III court, (3) Granfinanciera does not prevent a bankruptcy court from entering a final judgment on motions to dismiss and summary judgment motions on fraudulent transfer claims, and (4) the court in Stern expressly indicated that the decision was limited in its scope to a narrow set of circumstances that do not include fraudulent transfer claims. 2012 WL 6012149, at *10–11.

In Jenkins, the bankruptcy court opined that the job of the bankruptcy court is to “apply the law as it is written and interpreted today.” 2012 WL 6186347, at *2. The court noted that the Supreme Court may in the future hold that bankruptcy courts do not have the power to enter final orders in fraudulent transfer actions. See id. But as the law is written today, Congress has delegated the power to determine fraudulent transfer actions to the bankruptcy court. See 28 U.S.C. section 157(b)(1) & (b)(2)(H).

Preference
The only two cases during this period that addressed whether a bankruptcy court has the constitutional authority to determine preference actions were McDonald v. Little Limestone, Inc. (In re Powers Lake Constr. Co.), 482 B.R. 803 (Bankr. E.D. Wis. Nov. 28, 2012) and Shurn v. Gilbert (In re Gulf Coast Glass & Erection Co. Inc.), B.R., Adv. No. 12-03145, 2013 WL 125761 (Bankr. S.D. Tex. Jan. 10, 2013). Both courts answered in the affirmative. In Powers Lake Construction, the court reasoned that preference actions only exist as a matter of bankruptcy law and are unique and vital to bankruptcy because they serve one of bankruptcy’s fundamental goals: the equal distribution of estate property to creditors. McDonald, 482 B.R. at 805.

The bankruptcy court in Executive Sounding Board Associates, Inc. v. Advanced Mach. & Engineering Co. (In re Oldco M Corp.) was able to dodge the question of whether a bankruptcy court has the constitutional authority to enter a final order in preference matters. The bankruptcy court granted default judgment for the trustee because the defendant failed to respond to the complaint and summons. B.R., 2012 WL 6625324 at *1 (Bankr. S.D.N.Y. 2012). The bankruptcy court concluded that Stern did not limit the bankruptcy court’s authority based on such failure, and the same answer applied whether the claims in the complaint were characterized as “related-to,” core, or core but requiring an Article III judge to enter a final order or judgment. Id. at *2.

Consent
The question of whether Stern affected a party’s right to consent under 11 U.S.C. section 157(c)(2)—and if so whether consent must be express or implied—is perhaps the second most debated behind the fraudulent transfer issue. The Sixth Circuit in Machine & Fabrication, LLC v. Stone (In re Waldman) held that the bankruptcy court did not have the constitutional authority to enter a final order on fraud claims that an individual Chapter 11 debtor brought against a creditor even though the creditor arguably consented (expressly and impliedly). See Part IV at 1–2 (discussing Waldman). Nevertheless, the substantial majority of courts have held that Stern did not render section 157(c)(2) unconstitutional. Part I at 9–11; Part II at 9–10; Part III at 7–9; Part IV at 4. In fact, the Sixth Circuit in Waldman did not even mention section 157(c)(2). The more debated question is whether consent can be implied from conduct in litigation. See id.

The Ninth Circuit in Bellingham Insurance held that consent under section 157(c)(2) may be implied from conduct in litigation. See 2012 WL 6013836, at *12–14. The Ninth Circuit reasoned that the Supreme Court has already ruled on the issue of whether consent can be implied by conduct in litigation under a provision of the Federal Magistrate Act (28 U.S.C. section 636(c)) that is substantially similar to section 157(c)(2). See Roell v. Withrow, 538 U.S. 580 (2003) (“[t]he question is whether consent can be inferred from a party’s conduct during litigation, and we hold that it can be”). The circuit court also observed that, unlike section 157(e), section 157(c)(2) does not require “express” consent. 2012 WL 6013836, at *13.

The Bellingham Insurance court also noted that the defendant did not challenge the bankruptcy court’s authority until the appeal stage. See id. at *11–12. Other courts in this period determined that a party implied consent to bankruptcy court adjudication when it did not challenge the bankruptcy court’s authority until the appeal stage. See Blixseth v. Kirschner (In re Yellowstone Mountain Club), Adv. No. 09-00014, 2012 WL 6043282 (Bankr. D. Mont. Dec. 5, 2012); Bank of Nebraska v. Rose (In re Rose), B.R., No. 12-6046, 2012 WL 6621185 (B.A.P. 8th Cir. Dec. 20, 2012); Structural Inv. & Planning IV, LLC v. Pac. Cont’l Bank (In re Wash. Coast I, LLC), B.R., Adv No. 09-00553, 2012 WL 6879073 (B.A.P. Dec. 18, 2012).

Adversary Proceedings—Non-Avoidance Actions
In GMAC Mortgage, LLC v. Orcutt (In re Orcutt), a district court held that the determination of the validity of a mortgage neither involved substantive rights created by bankruptcy law nor constituted proceedings that by their very nature could only arise in the context of a bankruptcy case. No. 5:12-cv-96, 2012 WL 6552914 (D. Vt. Dec. 13, 2012). The court determined that the matter was purely a state law claim involving private rights. Id. at *11. Accordingly, the district court vacated the bankruptcy court’s declaratory judgment. The holding in Orcutt essentially is that 28 U.S.C. section 157(b)(2)(K) suffers from the same infirmity as section 157(b)(2)(C).

The Ninth Circuit Bankruptcy Appellate Panel reached the opposite conclusion of the district court in Orcutt. In Structural Investments & Planning IV, LLC v. Pac. Continental Bank (In re Washington Coast I, LLC), the bankruptcy appellate panel determined that the bankruptcy court had constitutional authority to enter a final order in a lien dispute. B.R., Adv No. 09-00553, 2012 WL 6879073 (B.A.P. 9th Cir. Dec. 18, 2012). The panel reasoned that the resolution of the lien dispute was part and parcel of the claims-resolution process and thus was integral to the restructuring of the debtor-creditor relationship. See id. at *10.

Contested Matters
During this period, several courts determined that Stern did not prevent the bankruptcy court from issuing final orders in contested matters. See, e.g., In re Stomberg, B.R., No. 10-41603, 2013 WL 142396 (Bankr. S.D. Tex. Jan. 10, 2013) (sanctions against attorney under Fed. R. Bankr. P. 9011(b) and (c)); In re Jackson, B.R., No. 06-36268, 2012 WL 6055008 (Bankr. S.D. Tex. Dec. 5, 2012) (employment application under section 327); Martinez v. Scotiabank de Puerto Rico, B.R., No. 12-1044, 2012 WL 5829632 (D.P.R. Nov. 16, 2012) (lift stay).

Counterclaims
Though they are buried among the dearth of post-Stern case law, there are matters where Stern is unquestionably relevant—matters where a bankruptcy court must determine whether it has the constitutional authority to rule on a bankruptcy estate’s counterclaims against a creditor’s proof of claim. Courts consistently employ the “Stern test” to determine whether the bankruptcy court has constitutional authority to rule on the counterclaim: (i) whether the counterclaim stems from the bankruptcy itself or (ii) whether resolution of the counterclaim is necessary for resolution of the proof of claim.

A great example of the application of the Stern test for counterclaims is Moses v. Cashcall, Inc. (In re Moses). In this case, a bankruptcy court determined that a plaintiff’s cause of action for a declaratory judgment that the defendant’s loan was void was “constitutionally core” as it was necessarily intertwined in the claims-allowance process. See No. 12-00174, 2013 WL 53873, at *3 (Bankr. E.D.N.C. Jan. 3, 2013). But on the other hand, the cause of action seeking actual damages for emotional distress and anxiety was not “constitutionally core,” as it did not affect the calculation of the creditor’s proof of claim. See id. at *4.

The Eleventh Circuit held that a bankruptcy court had authority to enter a final order on a state law recoupment counterclaim that was necessarily resolved in the process of ruling on a creditor’s proof of claim. Sundale, Ltd. v. Fla. Assoc. Cap. Enter. (In re Sundale, Ltd.), No. 12-11450, 2012 WL 5974125 (11th Cir. Nov. 29, 2012) (not selected for publication). Conversely, a district court in the Northern District of Georgia determined that the bankruptcy court would not have constitutional authority to enter a final order on state-law counterclaims, including civil conspiracy and tortious interference, because ruling on these counterclaims would not be necessary for ruling on the proofs of claims. Wi-Sky Inflight, Inc. v. Leabman (In re Wi-Sky Inflight, Inc.), F. Supp. 2d., Adv. No. 12-40490, 2012 WL 5353550 (N.D. Ga. Oct. 30, 2012).

Proposing Findings of Fact and Conclusions of Law in the Statutory Gap
The “statutory gap” theory suggests that Stern has left a third category of matters falling within the bankruptcy court’s jurisdiction: “core but unconstitutional.” 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 (as in Stern), 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 noncore matters. This concern has been almost universally rejected in every case decided after September, 2011. See Part I at 8–9; Part II at 12–13; Part III at 10–12; Part IV at 10–11.

Here, again, the Ninth Circuit in Bellingham Insurance contributes to the discussion. The circuit court determined that bankruptcy courts do not have constitutional authority to determine fraudulent transfer actions when the defendant has not filed a proof of claim or consented to the bankruptcy court’s authority. Despite the fact that fraudulent transfer matters are “core” under section 157(b)(1) and (b)(2)(H), the Ninth Circuit determined that the bankruptcy court could submit proposed findings of fact and conclusions of law despite the plain language of section 157(c)(1). See 2012 WL 6013836, at *9–10. The circuit court stated “[w]ith respect to any bankruptcy-related claim, then, the bankruptcy courts must be vested with as much adjudicatory power as the Constitution will bear.” Id. at *10. The court reasoned that the power to “hear and determine” fraudulent transfer actions that Congress conferred on bankruptcy courts surely encompasses the power to submit proposed findings and conclusions. See id.

Withdrawal of the Reference
The most common litigation tactic post-Stern is to move for withdrawal of the reference based on the theory that the bankruptcy court does not have authority to rule on a particular matter “under Stern.” This tactic has not proved successful for many litigants. See, e.g., Litigation Trust of The Rhodes Co., LLC v. Rhodes, Adv. No. 12-01099, 2012 WL 5456084 (D. Nev. Nov. 7, 2012) (denied withdrawal of the reference even after determining that bankruptcy court lacked constitutional authority to enter final order in section 544 and 548 actions); Sec. Inv. Prot. Corp. v. Bernard L. Madoff Invest. LLC, No. 12 MC 115, 2013 WL 67605 (S.D.N.Y. Jan. 4, 2013) (denying motion to withdraw the reference even after determining that the bankruptcy court lacked constitutional authority to enter final order in avoidance actions under SIPA).

Stern has influenced some courts in considering withdrawal of the reference. In Dynegy Danskammer v. Peabody Coaltrade Int’l Ltd., a Southern District of New York court granted a motion to withdraw the reference in a breach-of-contract action after determining that Stern modified the Orion factors (the core/noncore factor) for determining withdrawal of the reference motions in the Second Circuit. F. Supp. 2d, No. 12-cv-5859, 2012 WL 5464619 (S.D.N.Y. Nov. 7, 2012). In Wi-Sky Inflight, Inc. v. Leabman (In re Wi-Sky Inflight, Inc.), a district court determined that the bankruptcy court would not have constitutional authority to enter a final order on state-law counterclaims including civil conspiracy and tortious interference claims. F. Supp. 2d., Adv. No. 12-40490, 2012 WL 5353550 (N.D. Ga. Oct. 30, 2012). The court recognized that the bankruptcy court had the power to submit proposed findings of fact and conclusions of law under section 157(c)(1), but determined that because it would have to review the proposed findings and conclusions de novo, efficiency favored withdrawal of reference. See id. at *5.

Keywords: bankruptcy and insolvency litigation, Stern, jurisdiction, core, consent, gap, constitutional authority, fraudulent transfer

Omar J. Alaniz – March 13, 2013