Justices Affirm Bankruptcy Court Authority Over 'Stern' Claims
Reprinted with permission from the June 5, 2015 issue of The Legal Intelligencer. © 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
Over the last few years, bankruptcy attorneys and constitutional scholars have anxiously waited for clarification as to the scope of a bankruptcy court's authority to adjudicate certain state law claims. Now, restructuring practitioners are breathing a sigh of relief after last week's U.S. Supreme Court's decision in Wellness International Network Ltd. v. Sharif, 575 U.S. __ (2015), which, subject to litigant consent, allows a non-Article III bankruptcy judge to issue a final judgment on a claim that otherwise could only have been resolved in the district court. The Wellness decision is a welcome one: It clarifies that, notwithstanding constitutional barriers to having a bankruptcy judge issue a final ruling on certain "core" claims based on state law, parties may validly consent to adjudication by the bankruptcy court.
Back in 2011, the Supreme Court shook the bankruptcy bar with its Stern v. Marshall, 564 U.S. ___ (2011), decision, which decided that although bankruptcy courts have statutory authorization under 28 U.S.C. Section 157 to enter final judgments on certain state law counterclaims defined as "core" (now referred to as Stern claims), Article III of the U.S. Constitution prohibits bankruptcy courts from issuing final judgments as to those claims. The Stern decision reflects the underlying principle that Article III courts, which have original jurisdiction over bankruptcy cases and related proceedings, enjoy certain protections to ensure judicial integrity and independence, which include life tenure and a salary that cannot be diminished. Bankruptcy court judges, on the other hand, are appointed for 14-year terms and are subject to removal for cause. Moreover, bankruptcy courts adjudicate matters referred to them by the district court, which reference may be withdrawn upon a party's request or sua sponte. In this way, Article III courts act in a supervisory capacity and maintain control over the bankruptcy court process.
Three years after Stern, the Supreme Court in Executive Benefits Insurance Agency v. Arkison (In re Bellingham), 134 S.Ct. 2165, 2168 (2014), partially clarified the jurisdictional debate by ruling that while Article III prohibits bankruptcy courts from entering final judgments on Stern claims, bankruptcy courts could consider these as "non-core" claims and issue proposed findings of fact and conclusions of law to be reviewed de novo by the district court. The Bellingham decision, however, expressly left open the question of "whether Article III permits a bankruptcy court, with the consent of the parties, to enter final judgment on a Stern claim."
On May 26, the court resolved this issue in Wellness by holding that, with respect to Stern claims for which litigants are constitutionally entitled to Article III adjudication, "Article III is not violated when the parties knowingly and voluntarily consent to adjudication by a bankruptcy judge." In Wellness, the debtor, Richard Sharif, commenced a Chapter 7 proceeding after a $650,000 default judgment was obtained against him for attorney fees related to federal district court litigation that Sharif had commenced against Wellness International Network Ltd. As a creditor in Sharif's bankruptcy, Wellness obtained documentation in which Sharif previously attested to having more than $5 million in assets. In response, Sharif claimed that those assets were the property of a family trust (and not his). Wellness then filed a complaint in the bankruptcy court seeking, among other things, a declaration that the trust was Sharif's alter ego and that its assets belonged to the bankruptcy estate. Sharif's answer to Wellness' complaint admitted that the adversary proceeding was a "core proceeding" under 28 U.S.C. Section 157(b) such that the bankruptcy court would have authority to enter a final judgment.
After Sharif failed to satisfy discovery obligations in the adversary proceeding, the bankruptcy court found in favor of Wellness and declared that the trust assets were property of Sharif's bankruptcy estate. Sharif appealed the bankruptcy court's decision to the district court. While Stern was decided before Sharif's appeal was initially briefed by the parties, Sharif did not raise the Stern issue until he filed a motion for leave to file supplemental briefing, arguing that the bankruptcy court's order should be treated as a report and recommendation. The district court denied Sharif's motion as being untimely and affirmed the bankruptcy court. On appeal, however, the Seventh Circuit ruled that the bankruptcy court lacked constitutional authority to enter a final judgment in Wellness' declaratory action. The Seventh Circuit determined that Wellness' request for a declaratory judgment as to the alter ego status of the trust's assets was a Stern claim that could not, as a constitutional matter, be designated for final adjudication by the bankruptcy court.
The Supreme Court's Wellness decision examined the question of whether allowing a bankruptcy court to decide Stern claims—with the parties' consent—would threaten the institutional integrity of Article III courts. In answering this question, the court noted that it must consider the practical effects the decision "will have on the constitutionally assigned role of the federal judiciary." According to the court, where parties are given the opportunity to waive Article III adjudication, and where the federal judiciary retains its supervisory authority over the bankruptcy court's process, separation of powers concerns are diminished. The court held that a litigant's waiver of the right to Article III adjudication of Stern claims does not usurp the constitutional prerogatives of Article III courts (because the bankruptcy judges are under the supervision of Article III courts). The court also observed that it would be impractical to prohibit litigants from consenting to non-Article III adjudication of Stern claims as such an outcome would require a substantial increase in the number of district judgeships and change our federal judicial system's current "division of labor."
The Supreme Court also held that consent to bankruptcy court adjudication of a Stern claim need not be express but may be implied. However, any implied consent must be "knowing and voluntary." Therefore, it remanded the case for determination of whether Sharif's actions evinced the requisite knowing and voluntary consent and whether Sharif forfeited his Stern argument.
The primary dissent, authored by Chief Justice John Roberts Jr., disagreed with the court's decision, finding that, based on the court's holding in Stern, the bankruptcy court's issuance of a final judgment on Wellness' claim did not violate Article III because the legal issue of whether the trust assets were part of Sharif's bankruptcy estate is a matter falling clearly within the bankruptcy court's judicial authority. More importantly, Roberts disagreed with the court's holding arguing that the expansion of bankruptcy court authority over Stern claims (by consent) would compromise the integrity of the federal judicial system. In addition, he argued that private parties cannot consent to an Article III violation.
For most bankruptcy judges and practitioners, the court's Wellness decision is a welcome relief. For too long, the uncertainty regarding the authority of bankruptcy courts has created unnecessary inefficiency in bankruptcy litigation. Wellness clarifies that it is not unconstitutional for a bankruptcy court to hear a Stern claim when litigants have knowingly and voluntarily waived their right to be heard by an Article III court. This decision should streamline bankruptcy court adjudication of Stern claims: No longer will parties, who have consented to have their rights decided by the bankruptcy court, be able to subsequently challenge the constitutionality of the bankruptcy court's authority to issue final rulings on state law claims. In the future, parties may litigate whether the facts of a particular case demonstrate knowing and voluntary consent to final adjudication by the bankruptcy court, but even those disputes may be limited through the Federal Rules of Bankruptcy Procedure.
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