Yesterday, the Supreme Court issued its decision in the much-anticipated Wellness International Network, Ltd. v. Sharif.  And yesterday, we gave you the highlights of the decision.   Today, as promised, we bring you our more complete analysis on Wellness and its implications for bankruptcy matters moving forward. 

Background 

We’ve covered the underlying facts of the Wellness case here.  But in brief, Wellness sought a declaratory judgment from the bankruptcy court overseeing Sharif’s chapter 7 case that a trust administered by Sharif was Sharif’s alter ego and that the assets in that trust were therefore property of Sharif’s bankruptcy estate.  After Wellness obtained a default judgment, Sharif challenged the entry of that judgment, eventually raising arguments premised on Stern v. Marshall, arguing that in light of that (then-) new decision, the bankruptcy court had stepped outside its constitutional authority in issuing a final judgment in that action.  The Seventh Circuit agreed, holding that the Stern-based argument implicated structural interests inherent in the judiciary and that (i) the argument could be raised at any time on appeal, without concerns of waiver and (ii) the bankruptcy court did in fact lack constitutional authority to issue a judgment in Wellness’s action.  Accordingly, (i) Sharif could not have waived or forfeited his right to assert his Stern-based argument because it was premised on the structural integrity of the Judiciary, which could not be waived by failure to raise it in a timely manner, and (ii) bankruptcy courts cannot enter a final judgment on Stern claims (regardless of the litigants’ consent to same).

The Supreme Court granted certiorari on two questions:

  1. Whether the presence of a subsidiary state property law issue in a 11 U.S.C. § 541 action brought against a debtor to determine whether property in the debtor’s possession is property of the bankruptcy estate means that such action does not “stem[] from the bankruptcy itself” and therefore, that a bankruptcy court does not have the constitutional authority to enter a final order deciding that action.
  2. Whether Article III permits the exercise of the judicial power of the United States by the bankruptcy courts on the basis of litigant consent, and if so, whether implied consent based on a litigant’s conduct is sufficient to satisfy Article III.

The Majority Opinion

Interestingly, the majority decision focused only on the second question (declining, in a footnote, to express a view on the first question) and resolved the circuit split regarding whether litigant consent can cure constitutional deficiencies in a bankruptcy court’s authority to enter a final judgment.  Indeed, the decision suggests that, with consent, bankruptcy courts may enter a final judgment on both Stern claims (i.e., otherwise “core” claims as to which bankruptcy courts lack final adjudicatory authority), as well as non-core claims.

Writing for the 5-justice majority, Justice Sotomayor devoted considerable analysis to the current state of the federal courts.  Indeed, much of the decision is couched in terms of the powers of “non-Article III judges” (e.g., bankruptcy judges, magistrate judges, and the like), rather than limiting the analysis to the bankruptcy courts.  Relying on the data regarding the number of magistrate and bankruptcy judges and the voluminous caseload both in Article III courts and in bankruptcy courts, the Court acknowledged the important service rendered by non-Article III judges in the administration of legal proceedings.

The Court’s analysis started with the central principle undergirding its decision – “Adjudication by consent is nothing new.”  Reviewing Supreme Court precedent in CFTC v. SchorGomez v. United States, and Peretz v. United States, the Court reasoned that Congress may make available alternative forums, wherein litigants may elect to resolve their differences.  The key issue, then, is that litigants may elect to make use of these non-Article III forums; it was this distinction that warranted the opposite outcomes in Gomez andPeretz—namely, that magistrate judges may preside over jury selection in a felony trial where the defendant has consented to same, but may not preside over such matters in the absence of consent.  Citing to Schor, the Court observed that submitting “[such] disputes to a non-Article III adjudicator was at most a ‘de minimis’ infringement on the prerogative of the federal courts.”  In light of the foregoing, the Court concluded that the entitlement to an Article III adjudicator is a “personal right” and therefore “subject to waiver.”

The Court then went on to explain why this conclusion did not offend or threaten the separation of powers and the “institutional integrity” of the judiciary.  It reasoned that even if litigants may elect to proceed in bankruptcy court (or before magistrate judges), Article III judges continue to stand in supervisory capacity with respect to the non-Article III courts, insofar as those latter judges are appointed – and subject to removal – by Article III judges.  Moreover, both bankruptcy judges and magistrate judges hear matters solely by virtue of a reference from the Article III court.  And lastly, bankruptcy courts’ authority is inherently limited to “a narrow class of common law claims as an incident to the [bankruptcy courts’] primary, and unchallenged, adjudicative function.”  For these reasons, and because Congress had given no indication that it had created the regime on bankruptcy courts “in an effort to aggrandize itself or humble the Judiciary,” the Court saw no reason to bar litigants from consenting to have their disputes heard and determined by non-Article III courts, even if such a judgment would otherwise run afoul of the constitutional limitations on their authority.  This is particularly true in light of the fact that the current composition of the Judiciary depends on the presence of bankruptcy judges to “abl[y] assist[]” Article III judges in carrying out their duties.  Thus, it did not offend the majority that bankruptcy courts are a function of Congressional action pursuant to Article I of the Constitution, because the buck ultimate stops with the Article III courts, both systemically (in referring matters to the bankruptcy court) and individually (in appointing – or even removing – bankruptcy judges).

Having discussed the underlying support for its holding, the majority then explained that its conclusion was consistent with the initial Stern v. Marshall decision, which held that bankruptcy courts may not issue final judgments on core matters that (i) did not stem from the bankruptcy itself or (ii) would not be necessarily resolved in ruling on a proof of claim. Stern, the Court wrote, was “premised” on the fact that the parties in that case had not consented to adjudication of that dispute in the bankruptcy court, and therefore, Stern“does not govern the question whether litigants may validly consent to adjudication by a bankruptcy court.”  Moreover, the Court noted (as many courts have previously observed) that Stern itself specifically noted that it was a “narrow” decision that did not “change all that much” about the division of labor between bankruptcy and district courts – and if the Sternstood for the proposition that parties may not consent to adjudication before bankruptcy courts, it would necessarily “change much” about that division of labor.

In its last salvo on whether consent can cure erstwhile constitutional deficiencies in bankruptcy matters, the Court took issue with the principal dissent (discussed below), noting that if the Chief Justice’s dissent is to be believed, “the world will end not in fire, or ice, but in a bankruptcy court.”  Instead, the Court wrote, “[a]djudication based on litigant consent has been a consistent feature of the federal court system since its inception” and this reaffirmation of that fact “poses no great threat to anyone’s birthrights, constitutional or otherwise.”

In its final substantive section, the five-judge majority held that the consent described in the remainder of the opinion need not be “express” – rather it may also be implied from the parties’ conduct.  It based this conclusion on 28 U.S.C. §157, which authorizes bankruptcy judges to hear and determine non-core matters with the parties’ “consent,” and 28 U.S.C. §636(c), which authorizes magistrate judges to conduct certain proceeding with “the consent of the parties.”  Because the Court had previously held in Roell v. Withrow that §636(c) does not require express consent to proceed before magistrate judges, the Court concluded that the same logic should be applied to the similar language in section 157 regarding bankruptcy judges.  That being said, the consent must still be “knowing and voluntary” for the non-core or “Stern-type” matter to proceed to final judgment before the bankruptcy court.  In a footnote, however, the Court recognized that this issue may be a distinction without much of difference, insofar as the Bankruptcy Rules require such statements in non-core matters in adversary proceedings, and the current proposed amendments would require such statements regardless of whether a matter is core (and potentially a Stern matter) or non-core.

[Note: Moreover, many bankruptcy courts require express statements regarding consent or non-consent—either at the direction of the court, or in many cases, pursuant to local rules or orders of the court.]

Consequently, the Court remanded to the Seventh Circuit the issue of whether Sharif’s actions constituted “knowing and voluntary consent” and whether Sharif forfeited his Sternargument by not raising it sooner.  Interestingly, the Court here seems to be ruling, without stating so explicitly, that one can forfeit a Stern-based argument – contrary to what the Seventh Circuit held (although, unlike Justice Alito’s concurrence, the majority opinion does not express a view as to whether Sharif did, in fact, forfeit this argument).  Thus, it seems, a bankruptcy court can issue final judgments on Stern claims if either (i) the parties knowingly and voluntarily consent to such adjudication or (ii) the parties forfeit the Stern objection by not raising it soon enough.

The majority’s decision is well summarized by its own recognition that Congress’s efforts to align the responsibilities of non-bankruptcy judges “have not always been successful,” but that nevertheless, “Article III is not violated when the parties knowingly and voluntarily consent to adjudication by a bankruptcy judge.”

Justice Alito’s Concurrence

In a brief concurrence, Justice Alito agreed with the bulk of Justice Sotomayor’s majority opinion, noting that “[w]hatever one thinks of Schor, it is still the law of this Court, and the parties do not ask us to revisit it.”  Justice Alito disagreed with the majority, however, regarding whether the parties’ consent must be express, noting that he would require express consent before bankruptcy courts can enter a final judgment on a Stern claim.  Justice Alito observed that for a bankruptcy judge to enter a final judgment on non-core matters, 28 U.S.C. §157(c)(2) requires only “consent” while Bankruptcy Rule 7012(b)requires “express consent.”  However, he did not believe the Court needed to decide precisely what form of consent would suffice for a bankruptcy court to enter a final judgement on a Stern claim, as in his view, Sharif had already forfeited his right to raise a “Stern objection” by failing to raise it in the lower courts.

Justice Roberts’ Dissent

In a vigorous dissent, Justice Roberts, joined by Justice Scalia and Justice Thomas (in part), rejected the majority’s decision.  In the first instance, the dissent notes that the Court need not have even addressed the question of whether consent can cure constitutional deficiencies in a bankruptcy court’s authority because it would have decided the case on the first issue, which was ignored by the majority.  The dissent would have held that the claims before the court in Wellness “stem[med] from the bankruptcy itself,” insofar as they related to section 541 of the Bankruptcy Code and whether the res of Sharif’s bankruptcy estate included assets that Sharif purportedly held in a trust.  The claims, therefore, were not even Stern claims, but were instead core matters as to which the bankruptcy court had final constitutional authority from the outset.  Interestingly, it was Chief Justice Roberts himself who authored the majority decision in Stern, so his observations regarding the scope of matters that fit within that rubric is particularly interesting – even if not binding. [Note: It is all the more interesting that majority touts Stern as being premised on the lack of the parties’ consent — but such is the nature of precedent!]  As Chief Justice Roberts would have it, Stern was “a narrow decision” (as stated in Stern) not because parties could consent to adjudication of those claims in the bankruptcy court, but presumably because the universe of Stern claims was itself limited to narrow circumstances.

Turning, then, to the issue of consent, the dissent criticized the majority for basing its opinion on “pragmatic grounds,” stating that it “would not yield so fully to functionalism.”  With an almost religious fervor, Chief Justice Roberts cautioned the majority against interfering with the “sacred” separation of powers among the branches of the federal government.  He wrote that private litigants may relinquish individual, personal constitutional rights (such as a right to jury trial), but that they may not agree to stand trial in a forum that is not invested with the authority to hear and decide such matters.  A federal criminal defendant, for example, may not stand trial before a state court, a foreign court, or a moot court, merely by virtue of having consented to same.  Allowing bankruptcy courts, then, to decide Stern claims with the parties’ consent, would “impermissibly threaten the institutional integrity of the Judicial Branch.”

The dissent made short work of the cases involving magistrate judges (i.e.RoellPeretz, and Gomez), noting that they did not involve entry of a final judgment and were therefore inapposite.  The dissent then returned to its concern regarding the structural integrity of the discrete branches of the federal government, noting that the Legislative Branch (i.e., Congress) controls bankruptcy judges’ salary and tenure, and therefore enjoyed some degree of “legislative control” with respect to the judges.  Illustrating his concerns with the majority’s decision by describing the parade of horribles that could result from Article I judges being allowed to enter final orders with consent (slippery slope, anyone?), Chief Justice Roberts observed that Congress could conceivably seek to allow certain claims to be heard by judges who were under this “greater legislative control,” or could “find ways to ‘encourage’ consent [to final adjudication in bankruptcy court], say by requiring it as a condition of federal benefits.”  Fearful of a “steady erosion” of Article III judges’ authority, the Chief Justice joined James Madison and Alexander Hamilton in warning against Congress “inevitably seek[ing] to draw greater power into its ‘impetuous vortex.’”

Finally, returning to his religious imagery, the Chief Justice once again criticized the majority for holding that “a single federal judge . . . may assign away our hard-won constitutional birthright so long as two private parties agree.”  And invoking Jesus’s words in the New Testament (without attribution), Chief Justice Roberts ended his dissent with the following: “It profits the Court nothing to give its soul for the whole world . . . but to avoid Sternclaims?”

[Note: We at the Stern Files are unsure whether this reference was offered out of the Chief Justice’s flair for the dramatic, or whether it was somewhat tongue-in-cheek. Your thoughts?]

Justice Thomas’s Dissent

In a particularly academic dissent of his own, Justice Thomas concurred with part one of the Chief Justice’s dissent, noting that the issue before the Court could be easily resolved by holding that the matters before the court in Wellness were not Stern claims and therefore were within the bankruptcy court’s final authority, regardless of the parties’ consent or non-consent.  Justice Thomas then departed from the framework offered by the majority, Justice Alito, and the principal dissent, noting the inherent challenges in considering the issues initially raised in Stern.  Specifically, what is meant when the Court refers to “public rights” and “private rights”? And precisely what are the contours of the bankruptcy courts’ constitutional authority?  The analysis, therefore, need not be whether consent can cure the constitutional deficiencies with respect to Stern claims – but rather, whether the parties’ consent necessarily moots any constitutional concerns with respect to such claims, insofar as that consent could remove such claims from the realm of constitutional concerns regarding private rights.

Justice Thomas, without coming down on either side of the issue, observed that theWellness case (and, perhaps, the line of cases beginning with Stern) “implicates difficult questions about the nature of bankruptcy procedure, judicial power, and remedies” – questions that were not briefed by the parties and not meaningfully discussed by the majority (or the dissent, for that matter), but which merit close attention.

So What?

So, where are we after Wellness?  Is it the end of the world as we know it? Or is it just another day in bankruptcy court (paradise?) for you and me and the thousands of other bankruptcy practitioners in the post-Stern world?  Unfortunately, although the Court has given us guidance, in Arkison and Wellness, on what a bankruptcy court can do with Sternclaims, it has yet to provide firm answers to some of the most burning questions that have arisen in the wake of Stern.  For example, what is a Stern claim? What isn’t? In fact, the majority appears to have passed on an obvious opportunity to narrow the scope of Sternclaims by simply holding (or at least noting) that questions implicating the res of the bankruptcy estate pursuant to section 541 of the Bankruptcy Code are not Stern claims at all.  On the other hand, if the Court had adopted this reasoning, would section 541 make virtually every claim in bankruptcy a non-Stern claim?

Instead, the majority ruled on the issue of consent, which, notwithstanding the opinion’s emphasis on the courts’ heavy caseload and reliance on non-Article III judges, is only relevant insofar as the parties actually consent to final judgment by a bankruptcy court.   Indeed, in light of Arkison, bankruptcy courts can already (even before Wellness) hear all pretrial matters, and, in many cases, even proceed to the point of trial and report and recommendation for adoption by the district court upon de novo review (which, as we’ve noted, does not necessarily mean that the district court assesses all of the facts anew).  Perhaps the Court’s concern was less with bankruptcy courts, and more with ensuring that other non-Article III judges maintain their ability to hear and determine matters with litigants’ consent?

Moreover, the majority lost Justice Alito by venturing into the realm of express vs. implied consent, even though express consent must, in any case, be “knowing and voluntary.”  While we don’t necessarily disagree with the holding, this detour may not have been particularly relevant now that parties are generally required to indicate expressly at the outset of a proceeding whether they consent to the bankruptcy court entering final judgment on matters that may be outside the court’s final adjudicatory authority.  In that respect, the Court’s “functionalist” and “pragmatic” decision may be more concerned with decisions that have already been entered, but which may be pending appeal.  In concluding that consent may be implied from the parties’ conduct, the majority decision will allow appellate courts to reject appellants’ “gotcha” arguments invoking Stern in favor of setting aside judgments of the bankruptcy court, at least where the appellant did not adequately express its reservations in a timely fashion.

All that being said – we’re now more educated, but still somewhat confused.  Did the Court miss an opportunity to shed more light on Stern and its progeny, which will undoubtedly continue to constipate the courts with vigorous debate, even after Wellness?  What do we do about fraudulent transfer actions?  Preferences?  Section 541 and “property of the estate”?  Just what does “knowing and voluntary” implied consent really mean?

Is the Court out of touch with what actually goes on in bankruptcy cases?  Or should we be encouraged that four of our Supreme Court justices took the time to write lengthy (and passionate) opinions on a bankruptcy issue, of all things?

[PS: Don’t worry, Chief Justice Roberts. We’re not mad that you compared bankruptcy courts to moot courts. But we think we can distinguish between the two.]