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Mind the Statutory Gap (aka A Jurisdictional Mess)

As we all know, on June 9 of this year, the Supreme Court issued its long awaited decision in Executive Benefits Ins. Agency vs. Arkison, 134 S. Ct. 2165, 189 L. Ed. 2d 83 (2014), which we had hoped would resolve the open questions arising from Stern v. Marshall, 131 S. Ct. 2594, 180 L.Ed 2d 475 (2011).

In Stern v. Marshall, the U.S. Supreme Court held that even though bankruptcy courts are statutorily authorized to enter final judgments on a class of bankruptcy-related claims, Article III of the Constitution prohibits bankruptcy courts from finally adjudicating certain of those claims.  Stern however did not decide how bankruptcy courts should proceed when a “Stern type” claim is identified.

In Executive Benefits the Court went through some of the history of the case law that determines which claims may be adjudicated by a bankruptcy court and which may not be.  The Court distinguished between cases involving so-called “public rights,” which may be removed from the jurisdiction of Article III courts, and cases involving “private rights,” which may not.  Public rights are those related to the restructuring of the debtor-creditor relations, which is at the core of the federal bankruptcy power and which must be distinguished from the adjudication of state-created private rights that belong to an Article III court.

This public right and private right distinction was incorporated into the Bankruptcy Code by the statutory creation of core and non-core claims in 28 U.S.C. §157.  If a matter is core, the statute empowers the bankruptcy judge to enter a final judgment on the claim subject to appellate review by the District Court.  If the matter is non-core and the parties have not consented to a final adjudication by the bankruptcy court, the bankruptcy judge must propose findings of fact and conclusions of law to the District Court.  Then, the District Court must review the proceedings de novo to enter a final judgment.

In Stern, the Court considered a constitutional challenge to the statutory designation of a particular claim as “core.”  Section 157(b)(2)(c) lists “counterclaims by the estate against persons filing claims against the estate” as core proceedings.  The defendant in Stern challenged that designation and the Supreme Court agreed.

Stern made clear that some claims labeled by Congress as “core” may not be adjudicated by bankruptcy courts in the manner designated by 28 U.S.C. § 157(b).  Stern did not however address how the bankruptcy court should proceed under those circumstances.

Lower courts had accordingly described a “statutory gap.” A Stern claim may not be adjudicated by the bankruptcy court to a final judgment.  But the alternative procedure whereby the bankruptcy court submits proposed findings of fact and conclusions of law only applies to non-core claims.  Because Section 157(b) does not explicitly authorize bankruptcy judges to submit proposed findings of fact and conclusions of law in a core proceeding, the lower courts had held that there was a “statutory gap.”

In Executive Benefits, the Supreme Court held that because of the severability provisions built into the statute, even though it had found one part of the statute invalid (i.e., the designation of the counterclaim as core under §157(b)(2)(c), but constitutionally not passing muster as a public right), the balance of the statute was saved and therefore a Stern type claim could be handled as a non-core proceeding (i.e., the bankruptcy judge could submit proposed findings of fact and conclusions of law to the District Court).  The Court in Executive Benefits did not find it necessary to address whether or not consent was required, because it found that in this case there had been adequate Article III adjudication since the matter had been reviewed de novo by the District Court.

Therefore there is still the open question of whether consent is sufficient to accord a bankruptcy court jurisdiction to finally resolve Stern type claims.  The 9th Circuit in Executive Benefits had held that consent was sufficient, and as noted above, the Supreme Court did not rule on this issue.  However three other circuits have held that even with consent, a bankruptcy court may not enter judgment in a non-core proceeding (In re BP RE, L.P., 735 F.3d 279 (5th Cir. 2013); Wellness Int’l Network, Ltd v. Sharif, 727 F.3d 751 (7th Cir. 2013); Waldman v. Stone 698 F.3d 910 (6th Cir. 2012). The Supreme Court has granted certiorari in Wellness, which we hope will address once and for all whether consent is sufficient to accord the bankruptcy court jurisdiction over non-core matters.

Until then, different bankruptcy courts are dealing with the consent issue in different ways.  Some bankruptcy courts are amending their local rules to require a statement in the pleadings regarding not only whether the proceeding is core or non-core, but also whether the parties consent to jurisdiction.  This will work for now in circuits such as the 9th Circuit where consent is an adequate grant of jurisdiction, but it may not work even in the 9th Circuit if the ruling in Executive Benefits that consent is sufficient is overturned by Wellness.

In addition to the question of consent, another critical issue will be how to determine which “private rights” are Stern type claims.  What about preferences or turnover proceedings under 28 U.S.C. 157(b)(2)(e), or a determination of lien validity?  How will we make a determination as to whether or not a claim is a Stern type claim?  Presumably a litigant will need to make a motion early on in the bankruptcy case for a determination of that issue.  The 9th Circuit recently decided In Re Deitz, 12-60036, 2014 WL 3703834 (9th Cir. July 28, 2014), in which it held that a bankruptcy court may enter a final judgment on a claim for nondischargeability.  The 9th Circuit has stated that dischargeability actions are “central to federal bankruptcy proceedings,” and that they are “necessarily resolved during the process of allowing or disallowing claims against the estate.”  Carpenters Pension Trust Fund for N. Cal. v. Moxley, 734 F.3d 864, 868 (9th Cir. 2013).  “The dischargeability determination . . . therefore constitutes a public rights dispute that the bankruptcy courts may decide.”  Id.

Some of these questions may be answered by the Supreme Court’s grant of certiorari in Wellness on the consent issue.  That at least will resolve the Circuit Courts’ split as to whether or not consent adequately grants the bankruptcy court jurisdiction to resolve Stern type claims.

What about appellate proceedings, which can be a trap for the unwary?  If a bankruptcy court determines a claim to be core and an appeal is taken to the Bankruptcy Appellate Panel, also a non-Article III court, and the BAP determines that the claim is a Stern type claim, then the BAP’s review presumably will not cure the defect that was cured by an Article III court in Executive Benefits.

Undoubtedly the combination of Stern and Executive Benefits leaves us all a little uncertain, and undoubtedly litigation costs will increase in bankruptcy as each litigant vies for its court of choice.