Stern Revisited, Testing the Jurisdictional Authority of the Bankruptcy Courts and Beyond

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In January, the Supreme Court heard oral argument in Executive Benefits Insurance Agency v. Arkison. Executive Benefits is viewed by many as the sequel to Stern v. Marshall, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011).  In Stern, the Court held that bankruptcy courts lacked the constitutional authority to enter final judgment in a claim based exclusively on state law.  Writing for the majority, Chief Justice Roberts stated that “Article III protects liberty not only through its role in implementing the separation of powers, but also by specifying the defining characteristics of Article III judges.”  These characteristics include lifetime tenure and protection from salary diminution.  Unlike Article III judges, bankruptcy judges are appointed to fourteen-year terms, and their salaries are subject to diminution from Congress.  See 28 U.S. Code §§ 152(a)(1), 153(a)Stern “involve[d] the most prototypical exercise of judicial power: the entry of a final, binding judgment by a court with broad substantive jurisdiction, on a common law cause of action.”  The claim, however, “neither derive[d] from nor depend[ed] upon any agency regulatory regime.”  The Chief Justice warned:  “If such an exercise of judicial power may nonetheless be taken from the Article III Judiciary simply by deeming it part of some amorphous ‘public right,’ then Article III would be transformed from the guardian of individual liberty and separation of powers we have long recognized into mere wishful thinking.”

In Executive Benefits, which is on appeal from the Ninth Circuit (Bellingham Insurance Agency, Inc. v. Arkison, 702 F.3d 553 (9th Cir. 2012)), the Court will consider the following issues:

“1.  Whether Article III of the Constitution permits the exercise of the judicial power of the United States by bankruptcy courts on the basis of litigant consent, and, if so, whether “implied consent” based on a litigant’s conduct, where the statutory scheme provides the litigant no notice that its consent is required, is sufficient to satisfy Article III.

2.  Whether a bankruptcy judge may submit proposed findings of fact and conclusions of law for de novo review by a district court in a “core” proceeding under 28 U.S.C. § 157(b).

The case involves a husband and wife who owned Bellingham Insurance Agency, Inc. (“BIA”) and Aegis Retirement Income Services (“ARIS”).  ARIS did not have sufficient assets and could not operate independently.  Thus, ARIS “routed all its income and expenses through BIA, kept joint accounting records with BIA, and declared its income on consolidated tax returns with BIA.”

BIA later became insolvent, and closed its doors on January 31, 2006.  One day later, the husband used BIA funds to form Executive Benefits Insurance Agency, Inc. (“EBIA”).  Two weeks later, BIA assigned insurance commissions from one of its largest clients to a long-time employee of both BIA and ARIS.  Later in the year, $373,291.28 worth of commission income earned between January 1 and June 1 of that year was deposited into an account held jointly by ARIS and EBIA.  Of that amount, the employee deposited $123,133.58, and the remainder was deposited by EBIA.  “[A]ll of the deposits were credited to EBIA via an ‘intercompany transfer.’”

BIA had also filed for voluntary Chapter 7 bankruptcy in the Western District of Washington.  The bankruptcy trustee “filed a complaint against EBIA and ARIS in the same court to recover the commissions deposited into the EBIA/ARIS account,” alleging that the joint account was property of the estate.  The complaint contained eighteen causes of action, including federal and state preferential and fraudulent transfer claims, and a claim that “EBIA was a successor corporation of EBIA and therefore liable for its debts.”  The district court affirmed the judgment.

The bankruptcy court granted summary judgment in the trustee’s favor, and concluded that the deposits into the joint account were “fraudulent conveyances of BIA assets and that EBIA was a ‘mere successor’ of BIA.”  The bankruptcy court then entered judgment for $373,291.28.

After appealing to the Ninth Circuit, but before oral argument, EBIA moved to vacate the judgment for lack of subject matter jurisdiction.  Relying on Stern, EBIA, for the first time, argued that the “bankruptcy court was constitutionally prescribed from entering final judgment on the [t]rustee’s claims.”

Before reaching its decision, the Ninth Circuit discussed the history of the Supreme Court’s jurisprudence on the constitutional limits of Article I judges.  The Ninth Circuit began its discussion with a summary of the Court’s seminal decision of Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50, 102 S. Ct. 2858, 73 L. Ed. 2d 598 (1982).  In that case, a plurality of the Supreme Court held that assigning state law claims to a bankruptcy judge for resolution violated Article II, and that the only exceptions to Article III adjudication were territorial courts, military tribunals, and cases involving “public rights” rather than “private rights.”  The Court stated:  “Our precedents clearly establish that only controversies [involving public rights] may be removed from Article III courts and delegated to legislative courts or administrative for their determination.  Private-rights disputes, on the other hand, lie at the core of the historically recognized judicial power.”

The Ninth Circuit then discussed the progeny of Northern Pipeline, concluding with a discussion of Stern.  The Ninth Circuit held that “bankruptcy courts [do not] have the general authority to enter final judgments on fraudulent conveyance claims asserted against noncreditors to the bankruptcy estate.”  It further ruled, however, that bankruptcy courts could prepare recommendations for review by the district courts.  But the Ninth Circuit held that EBIA waited too long to challenge the bankruptcy court’s ruling as an Article III violation, and thus, EBIA had “impliedly consented to the bankruptcy court’s jurisdiction.”

At oral argument held on January 14, 2014, both Chief Justice Roberts and Justice Scalia expressed concern about expanding the authority of bankruptcy judges beyond the limits of Article III, and about permitting private citizens to give the bankruptcy courts authority that Congress itself could not give.

Other members of the Court, did not express the same skepticism as their colleagues, and inquired into the effect that the Court’s decision would have beyond the bankruptcy courts.  For example, Justice Kagan wondered if limiting the power of bankruptcy courts would affect the powers of independent arbitrators.  In response, the Chief Justice said that arbitration is a matter of contractual consent, and a court must still enter a judgment of an arbiter’s decision.   Justice Alito stated that Congress, consistent with the Supreme Court’s jurisprudence, gives magistrate judges some Article III powers, and that providing bankruptcy courts with similar powers is no different.  Both magistrate judges and bankruptcy judges, he said, may conduct an initial review for the district judges.  Counsel for EBIA argued that the bankruptcy court’s judgment was final, whereas a magistrate judge would have merely made a report and recommendation for the district court to review and enter judgment.  Justice Sotomayor, however, said that this was a mere technicality, and that even though a district court serves an appellate role after the entry of judgment from the bankruptcy court, the review by the district court is de novo.

The Court’s opinion in Executive Benefits, which is expected later this year, will affect not only bankruptcy judges, but other Article I judges as well.  For example, upon the consent of the parties, federal magistrate judges may hold jury trials in civil cases and enter final judgments in civil cases.  If the Court were to hold that litigants could not consent to give Article I judges (bankruptcy judges, magistrate judges, etc.) authority that they do not have under Article III, then the workload of the federal district courts will increase dramatically.  This increase would further strain the resources of the federal district and circuit courts.  Such a holding would also deprive the Bankruptcy Appellate Panels of the authority to hear state law claims, which would, in turn, increase the workload of the federal circuit courts.  Stay tuned to the Bond Bankruptcy Report for an update when the Court issues its decision.

Topics:  Article III, Consumer Bankruptcy, EBIA v Arkison, Jurisdiction, SCOTUS, Standing, Subject Matter Jurisdiction

Published In: Bankruptcy Updates, Civil Procedure Updates, Constitutional Law Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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