9th Circuit Issues Important Post-Stern Opinion

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[authors: Brad Duncan, Hugh McCullough]

On Dec. 4, 2012, the U.S. Court of Appeals for the 9th Circuit delivered its long-awaited decision in Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency, Inc.). The Bellingham decision effectively clears away much of the analytical underbrush that had surrounded—at least in the 9th Circuit —several important post-Stern v. Marshall questions.

Bellingham holds most clearly, and most importantly, that a bankruptcy judge lacks constitutional authority to render a final decision in a fraudulent conveyance action if the defendant has not asserted a claim in the bankruptcy proceeding itself. Extending the Supreme Court’s analyses in both Stern and Granfinanciera, S.A. v. Nordberg, the 9th Circuit forcefully declared that, in bankruptcy, the “public rights exception” to the requirement of Article III adjudication is analytically coextensive with the process of “restructuring the debtor-creditor relationship.” Because a fraudulent conveyance claim against a non-creditor defendant does not involve “restructuring the debtor-creditor relationship”—it is, rather, merely an attempt to “augment” the bankruptcy estate through the recovery of an asset—it falls outside the public rights exception. Because bankruptcy judges may only conclusively decide matters that fall within this exception, they are constitutionally precluded from deciding fraudulent conveyance actions against noncreditor defendants.

Importantly, the 9th Circuit refused to recognize any distinction for these purposes between fraudulent conveyance claims based only upon the Bankruptcy Code (Section 548) and those arising under state law. When asserted against noncreditors—which is to say, solely to augment the estate—both types of claim fall outside the public rights exception. The Bellingham opinion contrasted its facts with those in the 6th Circuit’s recent opinion in Onkyo Europe Elec. GMBH v. Global Technovations, where the 6th Circuit characterized as “crystal-clear” a bankruptcy court’s power to finally decide a fraudulent conveyance claim against a defendant which had filed a proof of claim. Under the Bellingham analysis, the filing of the proof of claim implicated the debtor-creditor relationship and brought the dispute within the public rights exception.

Bellingham resolves two other important issues. First, it holds that, even if a bankruptcy judge may not finally decide a fraudulent conveyance claim, he or she may make proposed findings of fact and conclusions of law, which are then subject to review by a district court. This resolves a technical issue that had arisen under the language of 28 U.S.C. 157, and which had led some bankruptcy courts—and, in dicta, the 7th Circuit in Ortiz v. Aurora Health Care, Inc.—to suggest that a bankruptcy court may lack statutory authority to decide much of anything at all in a fraudulent conveyance action against a noncreditor. Second, Bellingham holds that a noncreditor defendant in a fraudulent conveyance action may, by its conduct, waive its right to require an Article III adjudication of the claims. In fact, the 9th Circuit determined that the defendant in Bellingham had done precisely that—by failing to raise the constitutional issue below, and by presenting it for the first time on appeal, the defendant impliedly consented to the bankruptcy court’s conclusive determination of the fraudulent conveyance claim.

Bellingham provides important and needed guidance in fraudulent conveyance actions, at least in the 9th Circuit. The implications of its reasoning, though, may not be limited to fraudulent conveyance actions. There is no obvious reason why its central holding—that an action against a noncreditor does not implicate the debtor-creditor relationship, and thus falls outside the public rights exception—ought not apply to virtually all types of estate claims, including preference litigation and other matters. At the very least, Bellingham reinforces the need for bankruptcy practitioners and parties facing the prospect of bankruptcy litigation to consider the implications of virtually every act taken in a bankruptcy case, including—perhaps most importantly—the sorts of mundane steps, like filing a proof of claim or participating in motions practice, that previously had been taken for granted.