U.S. Supreme Court Clarifies Bankruptcy Court Jurisdiction but Leaves Some Questions Unanswered in Executive Benefits Insurance Agency v. Arkison

by Pepper Hamilton LLP
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The Supreme Court issued its decision in the closely followed case of Executive Benefits Insurance Agency v. Arkison, Chapter 7 Trustee of Estate of Bellingham Insurance Agency, Inc., 573 U.S. ___ (2014) (Bellingham) this morning, holding that where the Constitution bars a bankruptcy court from entering final judgment on a bankruptcy-related claim under the reasoning of Stern v. Marshall, 564 U.S. __, 131 S. Ct. 2594 (2011) (Stern), the court nevertheless is permitted to issue proposed findings of fact and conclusions of law to be reviewed de novo by the district court, which can then enter final judgment. This significant decision fills a “statutory gap” that had been created by Stern and provides a procedure by which bankruptcy courts may adjudicate claims that they were statutorily authorized but constitutionally prohibited from handling.

In Bellingham, a Chapter 7 bankruptcy trustee alleged that prior to filing for bankruptcy, the debtor, Bellingham Insurance Agency, Inc. (BIA), fraudulently conveyed certain of its assets to Executive Benefits Insurance Agency, Inc. (EBIA). The trustee filed an action asserting fraudulent conveyance claims against EBIA, which was not a creditor of BIA’s estate. The bankruptcy court granted summary judgment to the trustee and, on appeal, the district court affirmed after conducting a de novo review of the record. EBIA appealed to the Ninth Circuit, which observed that, under Stern, Article III did not permit a bankruptcy court to enter final judgment on a fraudulent conveyance claim against a noncreditor without the parties’ consent. Nevertheless, the Ninth Circuit affirmed on two alternative grounds: (i) the bankruptcy court’s adjudication of the fraudulent conveyance claim was permissible because EBIA had impliedly consented to the bankruptcy court’s jurisdiction, and (ii) the bankruptcy court’s judgment could be treated as proposed findings of fact and conclusions of law that were reviewed de novo by the district court, whose affirmance was sufficient to constitute the final judgment for Article III purposes.

Stern held that Article III prohibits Congress from vesting a bankruptcy court with the authority to finally adjudicate certain claims listed as “core” claims under 28 U.S.C. § 157(b), but the Supreme Court did not address how the courts should proceed when ruling on such a claim. Stern therefore left a “statutory gap” because a Stern claim cannot be adjudicated to final judgment by the bankruptcy court, as in a typical core proceeding, but the alternative procedure, whereby the bankruptcy court submits proposed findings of fact and conclusions of law, statutorily applies only to non-core claims under 28 U.S.C. § 157(c). This “gap” thereby arguably left bankruptcy courts devoid of any authority to act on Stern claims and required the district courts to hear all such claims in the first instance.

In Bellingham, the Supreme Court closed this “gap” by interpreting the plain language of the severability provision in 28 U.S.C. §151, which provides that where a “provision of th[e] Act or [its] application … is held invalid, the remainder of th[e] Act … is not affected thereby.” The Court held that when a court identifies a claim as a Stern claim, it has necessarily “held invalid” the application of Section 157(b), i.e., the “core” label and its attendant procedures, to the litigant’s claim. In such a case, to effectuate the statutory purpose, the “non-core” label and its associated procedures under Section 157(c) must apply. Assuming that the fraudulent conveyance claims at issue were Stern claims that could not be finally determined by the bankruptcy court, the Supreme Court found that the claims clearly were “related to” the bankruptcy case and, therefore, otherwise fit within the category of claims governed by Section 157(c). Thus, it was permissible for the bankruptcy court to follow the Section 157(c) procedures and submit proposed findings of fact and conclusions of law to the district court for de novo review. Because the district court had, in fact, engaged in a de novo review of the bankruptcy court’s order and entered its own final judgment, the Court ruled that any potential error in the bankruptcy court’s entry of final judgment had been cured.

In Bellingham, the Supreme Court authorized bankruptcy courts to provisionally adjudicate Stern claims by following the procedure established under Section 157(c), i.e., through submission of proposed findings of fact and conclusions of law to the district court for de novo review and final judgment. The opinion therefore provides a clear, constitutionally acceptable procedure for handling “core” claims that cannot be finally determined by the bankruptcy court.

However, Bellingham expressly reserves and does not decide whether Article III permits a bankruptcy court to enter final judgment, subject only to appellate review, on a Stern claim with the consent of the parties. In addition, the Supreme Court noted that the district court’s de novo review concluded in a written opinion. The requirement of a de novo review could add additional expense and require more time from already busy district courts.

 

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