Stern v. Marshall Update – Ninth Circuit Holds That Bankruptcy Courts Lack Constitutional Authority To Finally Determine Fraudulent Transfer Claims Against Non-Claimants

On December 4, 2012, the United States Court of Appeals for the Ninth Circuit added to the growing body of case law delineating the extent of bankruptcy courts’ jurisdiction in the wake the Supreme Court’s decision in Stern v. Marshall. In In re Bellingham Insurance Agency, Inc., the Ninth Circuit held that (i) non-Article III courts lack the Constitutional authority to enter final judgments in fraudulent transfer actions against non-claimants, (ii) bankruptcy courts may hear and enter findings of fact and conclusions of law in fraudulent transfer actions, and (iii) a defendant may waive its Constitutional right to be heard before an Article III court.[1]

Shortly before Bellingham Insurance Agency sought chapter 7 protection, it incorporated a new entity, Executive Benefits Insurance Company (“EBIA”), and facilitated the transfer of insurance commissions earned from one of Bellingham’s largest clients to an account held jointly by EBIA and another Bellingham affiliate. The chapter 7 trustee commenced an adversary proceeding against EBIA and the other affiliate, asserting, among other things, federal and state law fraudulent transfer claims and a claim that EBIA was a successor of Bellingham and therefore liable for its debts. EBIA, which did not file a proof of claim in the chapter 7 case, initially demanded a jury trial, which the district court treated as a motion to withdraw the reference from the bankruptcy court. However, EBIA subsequently petitioned the district court to stay its consideration of the motion to give the bankruptcy court time to adjudicate the trustee’s motion for summary judgment in the adversary proceeding. The bankruptcy court granted summary judgment in favor of the trustee, concluding that the transfer of Bellingham’s commissions to EBIA were fraudulent transfers and that EBIA was a successor of Bellingham. The district court affirmed the bankruptcy court’s ruling and EBIA appealed to the Ninth Circuit. Following the parties’ briefing on the appeal and on the eve of oral argument, EBIA objected – for the first time – to the bankruptcy court’s entry of a final judgment on the fraudulent transfer claims.

The Ninth Circuit held that the Supreme Court’s decisions in Granfinanciera, S.A. v. Nordberg and Stern v. Marshall compelled the conclusion that fraudulent transfer actions are not among the “public rights” that non-Article III courts may finally adjudicate. In Granfinanciera, the Supreme Court held that fraudulent transfer actions are not matters of “public right”, and that a non-claimant retains its Seventh Amendment right to a jury trial in a fraudulent transfer action brought pursuant to section 548 of the Bankruptcy Code. In Stern, the Supreme Court held that a bankruptcy court could not enter a final judgment on a state law tortious-interference claim because the claim was not a matter of public right, capable of being heard by a non-Article III court. In so holding, the Supreme Court found the tortious interference claim at issue in Stern to be indistinguishable from the fraudulent transfer claim at issue in Granfinanciera, concluding that both failed to fall within the public-rights exception to Article III adjudication. On this basis, the Ninth Circuit concluded that the trustee’s fraudulent transfer claims were not matters of public right, and accordingly, could not be decided outside an Article III court. The Ninth Circuit determined that its conclusion was further buttressed by the Supreme Court’s express equation in Granfinanciera of litigants’ Article III rights with their Seventh Amendment jury trial rights in bankruptcy-related cases, and characterization in Stern of cases involving Seventh Amendment jury trial rights as binding on the Article III issue.

The Ninth Circuit rejected the argument of several amici that Stern was distinguishable because it involved a state law cause of action, whereas the trustee’s federal fraudulent transfer claim was indistinguishable from the federal preference claim at issue in Katchen v. Landy. In Katchen, the Supreme Court held that bankruptcy referees acting under the former Bankruptcy Acts of 1898 and 1938 could exercise summary jurisdiction over a preference claim brought against a creditor who had filed a proof of claim in the bankruptcy proceeding. The Ninth Circuit reasoned that the critical distinction between the actions in Stern and Katchen was that the preference action in Katchen would necessarily be resolved in determining whether to allow the creditor’s claim. The Supreme Court in Stern, however, found that the state law claim at issue would not necessarily be resolved in the claims reconciliation process. Similarly, inasmuch as EBIA did not file a proof of claim in the bankruptcy case, the fraudulent transfer actions against EBIA would not be subject to resolution in any claims process. In addition, the Ninth Circuit found that classifying every federal law claim as a “public right” was incompatible with the Stern Court’s determination that only Article III courts may enter final orders on both the state law counterclaim in Stern and the federal law fraudulent transfer claim in Granfinanciera.

Having addressed the primary issue on appeal, the Ninth Circuit then turned to the question of whether bankruptcy judges may Constitutionally hear fraudulent transfer actions and prepare recommendations for de novo review by district courts. Section 157(b) of the Judicial Code delineates fraudulent transfer actions as “core” proceedings that bankruptcy courts may finally determine and section 157(c)(1) authorizes bankruptcy courts to issue reports and recommendations with respect to non-core matters. However, the Judicial Code is silent as to bankruptcy courts’ authority with respect to “core” matters that are Constitutionally reserved to Article III courts for final adjudication. The Ninth Circuit reasoned that the lack of explicit authority in the Judicial Code did not preclude bankruptcy courts from hearing such core matters because, if bankruptcy courts have the power to “hear and determine” core matters pursuant to section 157(b) of the Judicial Code, bankruptcy courts surely must possess the more limited power to submit proposed findings of fact and conclusions with respect to fraudulent transfer actions. The Ninth Circuit found also found support for this conclusion from the Supreme Court’s declaration in Stern that its holding should not upset the current division of labor in bankruptcy cases between bankruptcy and district courts.[2]

Lastly, the Ninth Circuit addressed the issue of EBIA’s implied consent to entry of a final judgment by a non-Article III court. In several decisions, including Stern, the Supreme Court has found that the right to be heard before an Article III court does not implicate subject matter jurisdiction and may be waived. Moreover, section 157(c)(2) of the Judicial Code permits bankruptcy courts to enter final orders in non-core proceedings with the parties’ consent. The Ninth Circuit concluded that if bankruptcy courts may enter final orders in non-core matters with the parties’ consent, then consent likewise allows bankruptcy courts to decide core matters that would otherwise be impermissible for bankruptcy courts to adjudicate. In addition, the Ninth Circuit determined that consent in this situation may be implied because section 157(c) of the Judicial Code only requires simple consent, in contrast to section 157(e), which permits bankruptcy courts to conduct jury trials only with the parties’ “express consent”. As EBIA abandoned its requests for a jury trial and failed to raise any Article III objection until the eleventh hour, the Ninth Circuit easily concluded that EBIA had impliedly consented to the Bankruptcy Court’s adjudication of the fraudulent transfer claims.

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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