Since 1984, the statutory scheme set forth in section 157 of the Judicial Code of the United States 1 has specified the role of bankruptcy courts in the adjudication of disputes. Section 157 divides the universe of proceedings into two categories: (i) core proceedings and (ii) proceedings that are not core but are related to the bankruptcy case. Section 157(b) contains a non-exclusive list of core proceedings, such as proceedings to confirm a chapter 11 plan, to determine the allowance or disallowance of claims, to turnover property of the estate, to terminate the automatic stay, and others. Section 157(b) gives bankruptcy judges the power to hear and determine core proceedings, including the entry of orders and judgments subject to traditional appellate review. In contrast, section 157(c) provides that in non-core proceedings bankruptcy judges may hear the matter, but may not render an order or judgment resolving the dispute unless the parties consent to the bankruptcy judge making such determination. Instead, the bankruptcy judge is to submit proposed findings of fact and conclusions of law to the district court, which shall hear the matter de novo if a timely objection is made to any proposed findings and conclusions.
This system worked relatively smoothly until 2011 when the Supreme Court decided the infamous case of Stern v. Marshall. 2 In Stern, the Supreme Court held that, despite listing “counterclaims by the estate against persons filing claims against the estate” as a core proceeding in section 157(b), it is unconstitutional for a bankruptcy judge to enter an order or judgment determining a certain common law counterclaim for tortious interference against a creditor of the estate. The Court reasoned that such counterclaim involved adjudication of a “private right,” not a “public right,” and, therefore, only an Article III life-tenured district court judge can adjudicate it. Bankruptcy judges are appointed for 14-year terms, rather than life tenure, and thus do not have the constitutional power to adjudicate “private rights.” The Court held that by including counterclaims in the list of core proceedings set forth in section 157(b), Congress improperly vested the bankruptcy court with the “Judicial Power of the United States,” which is reserved for Article III judges. After Stern, other courts have held that other proceedings listed as core,including fraudulent conveyance actions against parties that have not filed proofs of claim, involved “private rights” like the counterclaim for tortious interference in Stern and, therefore, such Stern-type proceedings could not be determined by bankruptcy judges.
As a result of Stern, courts have been divided on what role, if any, a bankruptcy court has in Stern-type proceedings (i.e., proceedings designated in section 157 as core, but which involve “private rights” that cannot be determined by bankruptcy judges). A number of courts, including the Court of Appeals in the Ninth Circuit in Executive Benefits, 3 have held that bankruptcy courts may treat such Stern-type proceedings as they treat non-core proceedings – that is, hearing such matters and submitting proposed findings of fact and conclusions of law to the district court. Indeed, in several districts, including the Southern District of New York, the district courts have revised their standing referral orders to expressly give bankruptcy judges the power to hear such Stern-type proceedings as if they are non-core proceedings. Those referral orders go so far as to provide that if a bankruptcy judge erroneously enters an order or judgment in a Stern-type proceeding, the district court may treat such order or judgment as proposed findings and conclusions subject to de novo review.
Other courts, including the appellate courts in the Sixth 4 and Seventh Circuits, 5 have held that the Stern decision actually left a “statutory gap” – since section 157(c) gives bankruptcy judges the power to hear a matter and submit proposed findings and conclusions only in non-core proceedings, they have no power to do so in core proceedings, including Stern-type proceedings that are listed in the statute as core. Those courts reason that in Stern-type proceedings, a bankruptcy judge can neither determine nor make proposed findings and recommendations to the district court. In essence, according to those courts, the bankruptcy judge has no role at all in such matters.
Another Stern-related issue on which courts have been divided is whether a bankruptcy judge may enter an order or judgment determining a Stern-type proceeding if the parties consent to the judge doing so. For example, the Court of Appeals for the Sixth Circuit has held that consent does not cure the constitutional limitations on a bankruptcy judge determining a Stern-type proceeding. By logical extension, those decisions raise the constitutionality of section 157(c), which provides that bankruptcy courts may determine non-core proceedings with consent of the parties. In contrast, the Court of Appeals for the Ninth Circuit in Executive Benefits held that a bankruptcy judge may enter a judgment determining a Stern-type proceeding if the parties consent to the judge having such power.
Executive Benefits Clarifies Role of Bankruptcy Judge in Stern-type Proceedings
On June 9, 2014, in the context of an adversary proceeding alleging fraudulent transfer claims, the Supreme Court of the United States in Executive Benefits Insurance Agency v. Arkison, 6 held by a vote of 8-0 that a bankruptcy court may treat a Stern-type proceeding as a non-core proceeding and issue proposed findings of fact and conclusions of law subject to a district court‟s de novo review. This decision upholds the practice in many districts, including the Southern District of New York and the District of Delaware, and is consistent with the standing referral orders adopted by the Southern District of New York and several other districts.
Lower Court Proceedings
In Executive Benefits, Nicolas Paleveda and his wife owned and operated two companies, Aegis Retirement Income Services, Inc. and Bellingham Insurance Agency, Inc. (“BIA”). By early 2006, BIA had become insolvent and ceased operation. Paleveda then used BIA funds to incorporate Executive Benefits Insurance Agency (“EBIA”). BIA then filed a voluntary chapter 7 bankruptcy petition in the Western District of Washington. The chapter 7 trustee filed a complaint against EBIA and others which, among other things, sought to recover as a fraudulent transfer the BIA assets conveyed to EBIA. The bankruptcy court granted the trustee‟s motion for summary judgment on all claims, including the fraudulent conveyance claims. EBIA appealed that determination to the district court, which affirmed the bankruptcy court‟s decision after de novo review and entered judgment for the trustee.
EBIA appealed to the Ninth Circuit and, following EBIA‟s filing of its opening brief, the Supreme Court decided Stern. In light of Stern, EBIA moved to dismiss the appeal in the Ninth Circuit for lack of jurisdiction on the grounds that Article III of the Constitution did not permit Congress to vest authority in a bankruptcy court to finally decide the trustee‟s fraudulent conveyance claims. The Ninth Circuit rejected EBIA‟s motion and affirmed the district court‟s decision holding that, even though a bankruptcy court is not authorized to enter a final judgment on a fraudulent conveyance claim against an entity that did not file a proof of claim unless the parties consent, EBIA had impliedly consented to the bankruptcy court‟s adjudication of the matter. Such implied consent was found from EBIA‟s conduct in petitioning the district court to stay its consideration of its motion to withdraw the reference and demand for a jury trial in the district court and in failing to object to the bankruptcy court‟s entry of a final judgment until after the briefing of its appeal was complete. The Ninth Circuit also noted that the bankruptcy court‟s judgment could instead be treated as proposed findings of fact and conclusions of law, subject to de novo review by the district court. EBIA then filed a petition for certiorari, which was granted by the Supreme Court.
Supreme Court Analysis of the “Statutory Gap” Issue
The Supreme Court found that it did not create any “statutory gap” in Stern because Stern-type proceedings may proceed as non-core proceedings within the meaning of section 157(c). The Supreme Court based its analysis on the severability provision contained in 28 U.S.C. § 151, which provides that “[i]f any provision of this Act or the application thereof to any person or circumstance is held invalid, the remainder of this Act, or the application of that provision to persons or circumstances other than those as to which it is held invalid, is not affected thereby.” The Court, therefore, explained that “the plain text of this severability provision closes the so-called „gap‟ created by Stern” because when a bankruptcy court determines it cannot enter a final judgment on a “core” claim under Stern, “it has necessarily „held invalid‟ the „application‟ of § 157(b) – i.e., the „core‟ label and its attendant procedures – to the litigant‟s claim.” 7 The Court concluded that if such claim is related to the bankruptcy case, which is a requirement for treatment as non-core matters, “the bankruptcy court simply treats the claims as non-core . . . [and] should hear the proceeding and submit proposed findings of fact and conclusions of law to the district court for de novo review and entry of judgment.” 8 It is interesting to note that the Court did not actually decide whether fraudulent conveyance claims are Stern-type claims, but noted that the court of appeals held, “and we assume without deciding, that the fraudulent conveyance claims in this case are Stern claims.” 9 The Court then held that the fraudulent conveyance claims were related to the bankruptcy case and thus should be treated as non-core.
No Resolution on Consent Issue
The Supreme Court held that the bankruptcy court‟s grant of summary judgment on the trustee‟s fraudulent conveyance claims was constitutional because the district court reviewed such decision de novo and issued a reasoned opinion affirming the bankruptcy court. The Court explained that “even if EBIA is correct that the Bankruptcy Court‟s entry of judgment was invalid, the District Court‟s de novo review and entry of its own valid final judgment cured any error.” 10 As a result, the Court declined to address whether EBIA had consented to the bankruptcy court‟s entry of a final judgment and reserved for another day the issue of whether such consent would be effective in allowing a bankruptcy court to enter final judgments in non-core or Stern-type proceedings.
The Supreme Court‟s decision in Executive Benefits will not alter current practice or necessitate any adjustments to the procedures or rules in most districts, including the Southern District of New York and the District of Delaware. In those districts, bankruptcy judges will continue to hear Stern-type proceedings and submit proposed findings of fact and conclusions of law subject to de novo review by the district court. The most far-reaching effect of the Court‟s decision, however, is what the Court did not decide. Unfortunately, a cloud of uncertainty will continue over whether bankruptcy courts may enter orders and judgments adjudicating Stern-type proceedings if the parties consent to the bankruptcy court doing so. The constitutionality of section 157(c)(2) of the Judicial Code, which permits a bankruptcy judge to determine non-core proceedings with the consent of the parties, also remains unclear. And even in those jurisdictions that hold that consent “works” to cure constitutional deficiencies in the bankruptcy court‟s power to adjudicate disputes, the question of whether such consent must be express or may be implied by the conduct of the parties will continue to challenge the courts.