Square Peg / Round Hole – The Supreme Court and the Constitutional Authority of U.S. Bankruptcy Courts

Kelley Drye & Warren LLP

The judicial power of the United States is vested in courts created under Article III of the Constitution. However, Congress created the current bankruptcy court system over 40 years ago pursuant to Article I of the Constitution rather than under Article III.  The Supreme Court has long held that Article I courts are limited to territorial courts, military tribunals, and courts created to hear cases involving “public rights” (e.g., cases involving claims of citizens against the government).  Claims of citizens against one another under state law, such as for breach of contract or common torts, are “private rights” that must be heard by an Article III judge.

Although it appears that all or nearly all of the justices on the Supreme Court believe that the United States bankruptcy courts are constitutional, the Court in recent years has significantly narrowed the “public rights” doctrine, which is the presumptive basis for such constitutionality. This has created confusion and given rise to substantial litigation in bankruptcy cases over the authority of bankruptcy judges to issue final orders on numerous issues.  The Court’s existing constitutional analysis regarding Article I bankruptcy courts and the public rights doctrine has come to resemble a square peg getting jammed into a round hole.  The Court needs to set forth a new rationale.

Uncertainty regarding the constitutional authority of bankruptcy courts has existed for decades, but was long quiescent until the Court’s opinion seven years ago in Stern v. Marshall.  That case was part of the tabloid fodder litigation between Anna Nicole Smith and the son of her late husband.  At some point Ms. Smith had filed for bankruptcy and Mr. Marshall filed a claim against her bankruptcy estate. The particular issue before the Court involved a state law tort counterclaim filed by Ms. Smith against Mr. Marshall.

Congress has the express power under Article I, Section 8 to pass uniform laws on bankruptcy.  Prior to Stern, it was generally believed that matters pertaining (in the Court’s words) to “the restructuring of debtor-creditor relations, which is at the core of federal bankruptcy power” under Article I, constituted a type of “public right” that could be heard and decided by an Article I bankruptcy judge.  However, the Court never handed down a clear ruling as to where the line between “public rights” and “private rights” should be drawn in bankruptcy proceedings.

The Court in Stern held that Congress could not authorize a non-Article III court to render a final determination on the state law tort counterclaim.  The ruling in Stern showed that the scope of what constitutes a “public right” susceptible to final determination by an Article I judge was narrower than previously understood.  Although the Court’s opinion in Stern purported to be limited, its analysis made clear that the public rights underpinning of the U.S. bankruptcy court system rested on shaky ground.

The problem created by the Supreme Court’s ruling in Stern is this: the Bankruptcy Code gives the bankruptcy courts power over all of a debtor’s bankruptcy estate.  Determining the disposition of a debtor’s estate is indisputably fundamental to “the restructuring of debtor-creditor relations.” But the Supreme Court has expressly stated in other cases that parties’ property and contractual rights in bankruptcy are based on state law; state law issues are therefore an inseparable part of virtually every bankruptcy case.  For purposes of determining “public” and “private” rights, which aspect of such adjudications should control?

A decision last term regarding the authority of an Article I forum in a non-bankruptcy case further demonstrates the need for the Supreme Court to replace the public rights doctrine as the basis for the constitutionality of bankruptcy courts. In a patent dispute case, Oil States Energy Services, LLC v. Greene’s Energy Group, LLC, one party challenged the constitutionality of a procedure known as “inter partes review”, an administrative process that permits parties to seek review by the Patent and Trademark Office (PTO) of patent grants.  Under this process, an administrative board within the PTO can invalidate the issuance of a patent, subject to appeal and review by the U.S. Court of Appeals for the Federal Circuit.

The Court held that the Article I administrative review process fell within the public rights doctrine and was permissible. However, it defined the doctrine so narrowly that the public rights doctrine can no longer realistically apply to bankruptcy courts.  The public rights doctrine according to Oil States applies to matters “arising between the government and others, which from their nature do not require judicial determination and yet are susceptible of it.”  This formulation simply cannot work for bankruptcy proceedings, which are not “between the government and others” and very much do “require judicial determination.”

The Court has attempted for many years to force bankruptcy courts to fit within the permissible historical parameters for Article I – territorial courts, military tribunals, and courts created to hear cases involving public rights – but that effort has run its course. Another basis for the constitutionality of bankruptcy courts must be articulated.

The answer should be as straight-forward as recognizing that specialized bankruptcy courts under Article I are an additional category of historical exception to the judicial power of Article III. Justice Scalia made this suggestion in a concurring opinion in Stern, and Justice Thomas expounded further on the idea in a recent dissenting opinion:

    Congress . . . has assigned the adjudication of certain bankruptcy disputes to non-Article III actors since as early as 1800. . . Bankruptcy courts clearly do not qualify as territorial courts or courts-martial, but they are not an easy fit in the “public rights” category, either. . . We have nevertheless implicitly recognized that the claims allowance process may proceed in a bankruptcy court, as can any matter that would necessarily be resolved by that process, even one that affects core private rights. . . . For this reason, bankruptcy courts . . . more likely enjoy a unique, textually based exception, much like territorial courts and courts-martial do. . .  That is, Article I’s Bankruptcy Clause serves to carve cases and controversies traditionally subject to resolution by bankruptcy commissioners out of Article III, giving Congress the discretion, within those historical boundaries, to provide for their resolution outside of Article III courts.

The Court should expressly recognize the United States bankruptcy courts as a fourth category of historical exception to Article III courts. This would place such courts on firm constitutional footing and end much of the uncertainty and needless litigation over bankruptcy judges’ authority.  The Court needs to stop trying to force the square peg of U.S. bankruptcy courts into the round hole of the public rights doctrine.

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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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