Recently, the Bankruptcy Court for the Eastern District of Louisiana stayed its own judgment pending an appeal to resolve doubt over the bankruptcy court’s authority to enter judgment on counterclaims related to a management agreement among Highsteppin’ Productions, L.L.C. (HSP) and debtors George Porter, Jr., Brian Stoltz, David Russell Batiste.  The bankruptcy court issued the stay despite HSP’s consent to the bankruptcy court’s entry of judgment and HSP’s failure to object to the bankruptcy court’s authority until losing at trial because the law “is in a serious state of flux and is subject to varying interpretation.”  The bankruptcy court’s decision highlights the reluctance of certain bankruptcy courts to enforce their own judgments given the uncertainty of whether Article III of the Constitution permits the exercise of judicial power by bankruptcy courts on the basis of party consent.  The Supreme Court’s grant of certiorari in Wellness Int’l Network v. Sharif on this issue, which we discussed on July 2, could not come soon enough.

Making Music and Litigation

What started with an agreement to manage a New Orleans funk trio soon went south and has landed in post-Stern limbo.  Starting on May 8, 2006, Massachusetts-based HSP managed the group Porter, Batiste, and Stoltz.  When the group broke up in 2009, HSP and its principal, Greg Stepanian, filed suit against the debtors in Massachusetts for repayment of personal advances, deferred commissions, and reimbursement of expenses incurred by HSP on behalf of the debtors.  The debtors filed chapter 7 petitions in Louisiana and removed HSP’s lawsuit to the bankruptcy court.  The debtors counterclaimed for breach of contract, breach of fiduciary duty, copyright violations, violation of the Massachusetts Unfair Trade Practices Act (MUTPA), and attorneys’ fees and costs recoverable under their MUTPA claims.  HSP filed adversary cases against each of the debtors seeking to determine the dischargeability of the debtors’ debt to them, which were consolidated with its original lawsuit.  HSP filed proofs of claim in the Porter and Stoltz bankruptcy cases for $608,878.28 and sought recognition of its proof of claim against Batiste in its adversary complaint.

The bankruptcy court denied HSP’s claims, found for the debtors on their breach of contract, MUTPA, negligence, and breach of fiduciary duty counterclaims, and denied the debtors’ copyright infringement claims.  In a second trial phase, the court awarded the debtors attorneys’ fees and costs for their MUTPA claims and denied HSP’s request for attorneys’ fees and costs for their defense of the copyright claim.  Despite their previous consent to the bankruptcy court entering judgment, after losing at trial, HSP and Stepanian sought a stay pending appeal alleging in support of their motion that the bankruptcy court lacked constitutional authority to enter judgment on the debtors’ counterclaims under Stern v. Marshall.  Although HSP and Stepanian later withdrew their Stern argument and informed the bankruptcy court that they would not argue Stern on appeal, the bankruptcy court nonetheless addressed the issue because HSP and Stepanian could raise it in future appeals.

A “State of Flux” Leads to a Stay

The bankruptcy court concluded that the debtors’ counterclaims were integral to the resolution of HSP’s claims against the debtors’ estates because the counterclaims involved interrelated and common issues of fact and law arising out of the management agreement between HSP and the debtors.  The bankruptcy court also found that it has authority to enter judgment on HSP’s counterclaims for attorneys’ fees and costs in the copyright action because HSP remained a potential creditor of the debtors’ estates until resolution of those counterclaims.  The bankruptcy court recognized that a broad interpretation of Stern would deny it authority to enter judgment on the attorneys’ fees claims because they arose from a separate set of facts than the other counterclaims.

The bankruptcy court found that the Fifth Circuit’s In re Frazin decision suggested that it had authority to make factual findings on debtors’ counterclaims because the debtors’ counterclaims had to be resolved to determine HSP’s claims against their estates.  The lack of a clear test in Frazin, in which three Fifth Circuit judges expressed three different rationales, however, left doubt as to the bankruptcy court’s authority.  The bankruptcy court also expressed surprise that the Supreme Court’s recent decision in Executive Benefits Insurance Agency v. Arkison, which we previously discussed on June 9, did not resolve whether party consent is sufficient to overcome a lack of constitutional authority when the consent question was “squarely presented” to the Court, although it did confirm that the court’s findings could be treated as proposed findings of fact and conclusions of law.  The bankruptcy court granted a stay pending appeal observing Frazin, Arkison, and other post-Stern cases led to a “serious state of flux” in the law and created the potential for a “waste of significant judicial resources” when a party such as HSP could grab a “second bite of the apple” by changing its position regarding bankruptcy court authority after an unsatisfactory result at trial.

Using the bankruptcy court’s reasoning, it is hard to see how a court could ever deny a stay pending appeal for a case involving state law counterclaims.  The bankruptcy court several times in its opinion expressed confidence that the resolution of the debtors’ counterclaims was necessary to resolve HSP’s claims against the estate, which it could have relied on in order to bolster its claim for authority.  The movants even had withdrawn their Stern objection.  That a stay was granted in this case demonstrates just how uncertain the law is regarding consent and other Stern issues following Arkison and the reluctance by bankruptcy courts to tread in such issues for fear of getting the answer wrong.

There is hope, though.  Now that the Supreme Court seems likely to determine the effect of consent on a bankruptcy court’s power to determine Article III questions, perhaps these uncertainties will be reduced.  Until the Supreme Court decides Sharif, the debtors and others like them may have to keep waiting.