September 17, 2014 Articles

The High Court Closes the Statutory Gap in Bankruptcy Procedure

The Court's ruling reaches the result that lower courts consistently arrived at prior to Stern v. Marshall.

By Catherine Steege and Melissa Root

On June 9, 2014, in its opinion in Executive Benefits Insurance Agency v. Arkison, the Supreme Court answered one of the most important questions left unanswered by its decision in Stern v. Marshall, 131 S. Ct. 2594 (2011): whether bankruptcy courts can recommend proposed findings of fact and conclusions of law in matters that were denominated as core under 28 U.S.C. § 157(b)(2) while, following Stern, the bankruptcy court lacked the constitutional authority to enter a final judgment order.

The argument that bankruptcy courts could not do so went as follows: (1) 28 U.S.C. § 157(c)(1), which authorizes bankruptcy courts to recommend findings and conclusions, applies only to “a proceeding that is not a core proceeding, but is otherwise related to a case under title 11” (emphasis added); (2) a matter that is statutorily defined as core (even if outside the bankruptcy court’s constitutional authority to decide) cannot be a non-core related matter; and (3) therefore, there is no basis in the statute for a bankruptcy court to recommend a ruling. Thus, proponents of the argument contended that there was a “statutory gap” or “dead zone” in the statute where the bankruptcy court lacked the statutory authority to do anything.

This argument led to absurd results. For example, if a trustee sued a defendant who had not filed a claim against the estate, the bankruptcy court could recommend a ruling in the adversary proceeding, and the case could proceed in bankruptcy court. But if the defendant determined that he or she did not like the way the case was going, all the defendant had to do was file a proof of claim against the estate, which would make the matter a core proceeding under 28 U.S.C. § 157(b)(2)(C) and place the case in the statutory gap, requiring a withdrawal to the district court. Not surprisingly, at the bankruptcy court and district court level, virtually every case to consider the argument rejected it—see In re Parco Merged Media Corp., 489 B.R. 323, 325–26 (D. Me. 2013) (collecting cases); In re TMG Liquidation Co., No. 7:12-629, 2012 WL 1986526, at *2 (D.S.C. June 4, 2012) (collecting cases)—as did the Ninth Circuit in In re Bellingham Insurance Agency, Inc., 702 F.3d 553, 565–66 (9th Cir. 2012).

The Supreme Court granted certiorari on this question in Executive Benefits because of a split between the Ninth and Seventh Circuits. The Seventh Circuit in In re Ortiz, 665 F.3d 906 (7th Cir. 2011), suggested in dicta that there was a statutory gap or dead zone in the statute. After the Court granted certiorari on this question, the Seventh Circuit actually held in Wellness International Network v. Sharif, 727 F.3d 751, 776–77 (7th Cir. 2013), cert. granted, 2014 U.S. LEXIS 4693 (July 1, 2014), that the dead zone existed and that bankruptcy courts lacked the statutory authority to do anything in cases that fell within the statutory gap, including even presiding over discovery.

The Court’s June 9, 2014, Executive Benefits decision put an end to the statutory gap debate. The Court affirmed the Ninth Circuit’s conclusion that the gap does not exist, concluding that the severability provision of the Bankruptcy Amendments and Federal Judgeship Act of 1984 (the 1984 Act) closed the so-called statutory gap. Exec. Benefits Ins. Agency v. Arkison, No. 12-1200, slip op. at 9 (U.S. June 9, 2014). To avoid the problems that followed the Court’s decision in Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), Congress included a severability clause in the 1984 Act that provided that “[i]f any provision of this Act or the application thereof to any person or circumstance is held invalid, the remainder of the Act, or the application of that provision to persons or circumstances other than those as to which it is held invalid, is not affected thereby.” 98 Stat. 344 (note following 28 U.S.C. § 151). Under this provision, when a bankruptcy court identifies a claim as a “Stern claim” (i.e., one it cannot constitutionally decide to a final judgment), the statute instructs that “the remainder of Act . . . is not affected thereby.” Executive Benefits, slip op. at 10. That remainder, the Court reasoned, includes the authority to hear and recommend rulings in non-core claims. Id. The Court also noted that its own general approach to severability comported with this result because nothing in section157 or its historical context suggests that Congress would have preferred “to suspend Stern claims in limbo.” Id.

The Court’s reading of Stern—i.e., limiting section 157(b)(2)’s list of core matters to include only those over which the bankruptcy court may constitutionally enter final judgment—also is consistent with pre-Stern case law, which read this list as being limited by Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982). Before Stern, courts read the broad grant of core authority found in section 157(b)(2)(A) and (O) covering “matters concerning the administration of the estate” and “other proceedings affecting the liquidation of the assets . . . ,” which conceivably would cover virtually every matter before the bankruptcy courts, as being limited by Marathon. When the exercise of core authority exceeded Marathon’s limits, the courts previously treated the matters as non-core, thereby allowing the bankruptcy courts to recommend rulings. See, e.g., Barnett v. Stern, 909 F.2d 973, 979–80 (7th Cir. 1990). Thus, the Court’s ruling closing the statutory gap reaches the result that lower courts consistently arrived at prior to Stern.

Executive Benefits should eliminate much of the post-Stern forum shopping. The Seventh Circuit’s extreme result in Wellness—that bankruptcy courts can do nothing in cases involving Stern claims—no longer compels the district courts to withdraw the reference on Stern claims. Thus, absent a jury trial right, these cases will likely remain in the bankruptcy courts, where they will often be settled or otherwise resolved without need for the district court to review the bankruptcy court’s proposed ruling. Indeed, as the Court noted, Stern concluded that the “removal of claims from core bankruptcy jurisdiction does not ‘meaningfully change[e] the division of labor in the current statute.’” Executive Benefits, slip op. at 10 n.8 (quoting Stern, 131 S. Ct. at 2620). Requiring the district court to hear all Stern claims in the first instance would “dramatically alter the division of responsibility set by Congress.” Id.

One question left open by Executive Benefits is “whether Article III permits a bankruptcy court, with the consent of the parties, to enter final judgment on a Stern claim.” Id. at 4 n.4. In Executive Benefits, the Court stated that it “reserve[d] that question for another day.” Id. “Another day” may come as soon as the Court’s next term. Less than a month after deciding Executive Benefits, the Court granted certiorari in the Wellness caseon two questions, one of which was whether Article III permits the exercise of the judicial power of the United States by the bankruptcy courts on the basis of litigant consent and, if so, whether implied consent based on a litigant’s conduct is sufficient to satisfy Article III.

Keywords: bankruptcy and insolvency litigation, section 157, statutory gap, Executive Benefits Insurance Agency v. Arkison, Stern v. Marshall

Catherine Steege and Melissa Root – September 17, 2014