Lower court decisions
Concurring and dissenting opinions
On June 23 2011 the Supreme Court, in a five-to-four vote in Stern v Marshall,(1) held that a bankruptcy court lacks the constitutional authority to enter final judgment on a counterclaim asserted by a debtor where the counterclaim is unrelated to the underlying claim. In affirming the decision of the US Court of Appeals for the Ninth Circuit, the Supreme Court found that although the bankruptcy court, which has judges that are appointed for limited terms, had been given the statutory authority under 28 USC § 157 to make final decisions on such counterclaims, it does not have the authority to do so under Article III of the Constitution. Therefore, the decision distinguished between core and non-core counterclaims, and makes clear that only core counterclaims can be adjudicated with finality by bankruptcy courts.
The action before the Supreme Court was the culmination of an epic set of lawsuits between Vickie Lynn Marshall and E Pierce Marshall. Vickie (known to the public as Anna Nicole Smith) was Pierce's father's third wife. Although Pierce's father gave Vickie many gifts during their courtship and marriage, he did not include her in his will. Shortly before Pierce's father died, Vickie filed suit in Texas state probate court against Pierce, asserting that he had fraudulently induced his father to sign a living trust that did not include her. After Pierce's father had died, Vickie filed for bankruptcy protection in the US Bankruptcy Court for the Central District of California. Pierce filed a complaint (and an accompanying proof of claim) in Vickie's bankruptcy proceeding for defamation. Vickie responded to the action by, among other things, filing a counterclaim for tortious interference (the same cause of action as the Texas state probate court suit).
The bankruptcy court concluded that Vickie's counterclaim was a "core proceeding" under 28 USC § 157(b)(2)(C), and therefore it had the "power to enter judgment" on it. It ruled in favour of Vickie on all counts:
- granting her summary judgment on Pierce's defamation claim; and
- awarding her over $400 million in compensatory damages and $25 million in punitive damages on her counterclaim.
The US District Court for the Central District of California disagreed with the bankruptcy court's conclusion that the counterclaim was a core proceeding. It recognised that the counterclaim fell within the literal language of 28 USC §157(b)(2)(C), but understood that Supreme Court precedent suggests that it would be unconstitutional to hold that any and all counterclaims are core proceedings. Thus, the district court determined that it was required to treat the bankruptcy court's judgment as proposed rather than final.(2) In conducting its own independent review of the record, the district court declined to give the Texas state court judgment(3) preclusive effect, and instead ruled that Pierce tortiously interfered with Vickie's expectancy of a gift from Pierce's father.
The appeal court reversed the district court's decision on different grounds(4) and the Supreme Court reversed. On remand from the Supreme Court, the appeal court held that in order to constitute a core proceeding under Section 157, the counterclaim must be so closely related to the creditor's proof of claim that the resolution of the counterclaim is necessary to resolve the allowance or disallowance of the claim itself. It further held that Vickie's claim did not meet this test and that the Texas state court's judgment should be afforded preclusive effect.
The Supreme Court granted certiorari to determine:
- whether the bankruptcy court had statutory authority under 28 USC §157(b) to issue a final judgment on Vickie's counterclaim; and
- if so, whether conferring that authority on the bankruptcy court was constitutional.
Under 28 USC §157(b), bankruptcy judges may hear and enter final judgments "in all core proceedings arising under title 11, or arising in a case under title 11". Section 157(b)(2)(C) enumerates a non-exclusive list of 16 different types of matter that are considered core proceedings, including "counterclaims by [a debtor's] estate against persons filing claims against the estate". When a bankruptcy judge determines that a proceeding is not a core proceeding, but "is otherwise related to a case under title 11", the judge may only "submit proposed findings of fact and conclusions of law to the district court". The district court then conducts its own independent review before entering a final judgment.
Pierce's counsel argued that Vickie's counterclaim did not qualify as a core proceeding within the meaning of Section 157(b) because Section 157(b) allows a bankruptcy judge to make a final judgment on a core proceeding only if that proceeding also arises in a Title 11 case or under Title 11 itself. In the alternative, Pierce's counsel asserted that the bankruptcy court lacked jurisdiction to enter final judgment on his defamation claim because his defamation claim was a "personal injury tort" claim that, under Section 157(b), shall be tried in the district court.
Chief Justice Roberts, writing for the majority,(5) rejected Pierce's interpretation of Section 157(b) and held that Vickie's counterclaim was a core proceeding under the plain text of Section 157(b)(2)(C). The majority found that Pierce's reading contradicted the plain meaning of the statute, and that agreeing with his interpretation would result in a rewriting of the statute. That interpretation necessarily assumed that there is a category of non-core proceedings that arise neither under Title 11 nor in a Title 11 case. No such category exists, and the statute does not instruct bankruptcy judges on what to do with respect to such proceedings.
The majority similarly rejected Pierce's counsel's jurisdictional argument. Section 157 addresses only where personal injury tort claims "shall be tried", and does not refer to any court's jurisdiction or implicate questions of subject-matter jurisdiction. Furthermore, Chief Justice Roberts found ample evidence in the record that Pierce consented to the bankruptcy court's resolution of his claim.(6) On this basis, the court declined to address what constitutes a "personal injury tort" claim within Section 157(b), but noted that this issue raises questions on which there is little consensus or precedent.
While the majority ruled that the bankruptcy court had statutory authority to enter a final judgment on Vickie's counterclaim, it noted that designating all counterclaims as core proceedings "raises serious constitutional concerns". Roberts, writing for the majority, concluded that while Section 157(b)(2)(C) would permit the bankruptcy court to enter a final judgment on Vickie's counterclaim, Article III of the Constitution did not.
Article III, Section 1 of the Constitution mandates that "[t]he judicial Power of the United States, shall be vested in one supreme Court, and in such inferior Courts as the Congress may from time to time ordain and establish". The same section provides that the judges of those constitutional courts "shall hold their Offices during good Behaviour" and "receive for their Service...a Compensation...[that] shall not be diminished" during their tenure.
Vickie's counsel argued that the bankruptcy court's final judgment on Vickie's state common law counterclaim was constitutional under the 1984 amendments to the Bankruptcy Code(7) or, in the alternative, that the counterclaim fell into the public rights exception. Vickie's counsel distinguished prior Supreme Court precedent in Granfinanciera, SA v Nordberg and Langenkamp v Culp by arguing that Pierce had filed a proof of claim against Vickie's estate, and therefore submitted himself to the jurisdiction of the bankruptcy court. Vickie's counsel also asserted that as a practical matter, restrictions on the bankruptcy courts' ability to hear and resolve compulsory counterclaims would create significant delays and impose additional costs on the bankruptcy process.
The majority rejected Vickie's counsel's arguments and found that the bankruptcy court lacked constitutional authority to enter a final judgment on a state law counterclaim that was not resolved through the bankruptcy claims process. It found that the bankruptcy court was clearly exercising the "judicial Power of the United States", as the counterclaim was a state law claim. The majority further ruled that the counterclaim did not fall within the public rights exception, as it was a state common law claim between two private parties and the terms of its adjudication did not depend on Congress. In addition, Vickie's requested relief did not flow from a federal statutory scheme and was not completely dependent on adjudication of a claim created by federal law.
In addition, the court dismissed Vickie's argument distinguishing Granfinanciera and Langenkamp(8) because the adjudication of Pierce's claim in no way affected the nature of Vickie's counterclaim. Although the court did not rule directly on this issue, when Granfinanciera and Langenkamp are read together with the current decision, fraudulent conveyance and preference actions brought against non-creditors and creditors could be interpreted to be outside of the public rights exception and thus outside of the jurisdiction of bankruptcy courts such that they must be adjudicated by district courts.
Finally, the majority was not convinced that the practical consequences of limiting the bankruptcy courts' authority to enter final judgments would be as significant as Vickie's counsel suggested. The 1984 amendments and Section 157(c)(1) contemplate that certain state law matters would not be resolved with finality by the bankruptcy courts and, as a result, the majority did not believe that removal of counterclaims such as Vickie's from core bankruptcy jurisdiction would meaningfully change the existing division of labour.
Concurring and dissenting opinions
Justice Scalia, while agreeing with the majority's opinion, separately wrote a concurring opinion. He noted that the public rights exception must be read narrowly, and that unless there is a firmly established historical practice to the contrary, an Article III judge (ie, those appointed by the president and confirmed by the Senate) is required in all federal adjudications.
Justice Breyer, joined by Justice Ginsburg, Justice Sotomayor and Justice Kagan, dissented. Breyer agreed with the majority that Section 157(b)(2)(C) authorised a bankruptcy court to adjudicate Vickie's counterclaims, but disagreed with the majority about the statute's constitutionality. The dissent contended that the statute is constitutional because, among other reasons:
- the resolution of counterclaims often turns on facts identical, or at least related, to those at issue in a creditor's claim that is undisputedly proper for the bankruptcy court to decide;
- bankruptcy judges are appointed by federal courts of appeal - they can functionally be compared to magistrate judges, law clerks and the judiciary's administrative officials;
- Article III judges retain control and supervision over the bankruptcy court's determinations so there are sufficient checks on the bankruptcy court's judgments; and
- the parties consented to the jurisdiction of the bankruptcy court.
Regarding Vickie's counsel's argument of the practical consequences, the dissent agreed and believed that limiting bankruptcy courts' authority would lead to inefficiency, increased cost, delay and needless additional suffering among those faced with bankruptcy.
As a practical matter, the Supreme Court decision likely does not affect most creditors. Although it discussed both issues briefly, the court left open the definition of a 'personal injury tort' for the purposes of Section 157(b) and how this decision, when read with Granfinanciera and Langenkamp, impacts on avoidance actions against parties which did not submit proofs of claim against the bankruptcy estate. The only direct implication of the decision is in cases where a debtor files a counterclaim that is unrelated to the underlying claim filed against the debtor. In such a scenario the counterclaim still may be heard by the bankruptcy judge, who will issue proposed findings of fact and conclusions of law to the district court; and then by the district court, which will conduct an independent review of the record before entering a final order. However, to avoid what could be a substantial inefficiency of having only proposed findings being issued by the bankruptcy court, it is more likely that the counterclaim will be withdrawn to the district court to allow it to hear the matter directly.
For further information on this topic please contact Fredric Sosnick at Shearman & Sterling LLP by telephone (+1 212 848 4000), fax (+1 212 848 7179) or email ([email protected]).
(1) 564 US ____, Case 10-179 (June 23 2011).
(2) As discussed further below, under 28 USC § 157(b), bankruptcy judges may hear and determine "all core proceedings arising under title 11, or arising in a case under title 11... and may enter appropriate orders and judgments". For all non-core proceedings, under Section 157(c)(1) a bankruptcy court may hear the proceeding but it may only "submit proposed findings of fact and conclusions of law to the district court".
(3) The Texas state court conducted a jury trial on the merits of the parties' dispute, and entered a judgment in Pierce's favour.
(4) The appeal court initially ruled that the bankruptcy court lacked jurisdiction because the tortious interference was, in substance, nothing more than a thinly veiled wills contest that came within the exclusive jurisdiction of the Texas probate court (392 F 3d 1118 (2003)).
(5) Justices Kennedy, Thomas, Alito and Scalia joined the majority opinion.
(6) For example, the court noted that:
- Pierce did not object to any court that Section 157(b)(b) prohibited the bankruptcy court from resolving his defamation claim until over two years after he filed that claim; and
- Pierce advised the bankruptcy court that "he was 'happy to litigate [his] claim' there".
(7) The Bankruptcy Code amendments of 1984 were enacted after the Supreme Court's decision in Northern Pipeline Constr Co v Marathon Pipe Line Co (458 US 50 (1982)). In Northern Pipeline the Supreme Court concluded that bankruptcy judges (serving under the Bankruptcy Act of 1978 – appointed by the president and confirmed by the Senate, but lacking the tenure and salary guarantees of Article III) could not, under Article III, be constitutionally vested with jurisdiction to decide state law contract claims against an entity that was not otherwise part of the bankruptcy proceedings. The court there explicitly found that state law contract claims did not fall under the public rights exception. After this decision, Congress revised the statutes governing bankruptcy jurisdiction and bankruptcy judges. In the 1984 amendments, Congress provided that:
- judges of the new bankruptcy courts would be appointed by the courts of appeal for the circuit in which their districts are located; and
- the newly constituted bankruptcy courts could enter final judgments only in core proceedings.
(8) In Granfinanciera the court held that a fraudulent conveyance action filed by a bankruptcy trustee against a non-creditor in a bankruptcy proceeding did not fall within the public rights exception, and thus the non-creditor is entitled to a trial by jury (492 US 33 (1989)). In Langenkamp the court held that parties which submitted claims against the bankruptcy estate are not entitled to a trial by jury when sued by the bankruptcy trustee to recover allegedly preferential transfers (498 US 42 (1990)). Vickie's counsel argued that because Pierce filed a proof of claim against Vickie's estate, he submitted himself to the jurisdiction of the bankruptcy court.