Irving Picard, the trustee appointed under the Securities Investor Protection Act (the “Trustee”), 15 U.S.C. § 78aaa et seq. (“SIPA”), to administer the estate of Bernard L. Madoff Investment Securities, LLC, has brought hundreds of actions seeking to avoid transfers that were purportedly fraudulent or preferential (the “Avoidance Actions”). Some of the Avoidance Action defendants sought to withdraw the reference to the Bankruptcy Court, basing their motions on the Supreme Court’s decision in Stern v. Marshall, 131 S. Ct. 2594 (2011). The Stern case held that, notwithstanding the designation as “core” under 28 U.S.C. § 157(b)(2), a bankruptcy court is not constitutionally authorized to enter final judgment on a state law counterclaim that is not resolved in the process of adjudicating a creditor's proof of claim.

However, the Stern decision did not expressly define the particular scope and authority of bankruptcy courts to hear and make final decisions in connection with cases such as the Avoidance Actions. Accordingly, the United States District Court for the Southern District of New York (the “District Court”), in Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 2013 U.S. Dist. LEXIS 2517 (S.D.N.Y. Jan. 4, 2013) (hereinafter, “SIPC v. Madoff”), consolidated numerous motions to withdraw the reference in order to clarify three specific issues in connection with the Avoidance Actions:

  1. Whether the Bankruptcy Court has the judicial authority to finally decide the Avoidance Actions;
  2. Whether the Bankruptcy Court has the judicial authority to recommend proposed findings of fact and conclusions of law to the District Court; and
  3. Whether the District Court should with - draw the reference in light of Stern. Constitutional and Statutory

Constitutional and Statutory Background

To resolve these issues, the District Court initially reviewed Article III of the Constit - ution, noting that Congress is restricted in withdrawing certain issues from the “judicial cognizance” of Article III judges. Bankruptcy judges are not Article III judges (they are sometimes referred to as “Article I” judges), and therefore, Congress may only empower bankruptcy courts to determine and finally resolve certain claims involving “public rights,” but not matters involving “private rights.” Stern, 131 S. Ct. at 2609. The District Court noted that public rights “relate to the performance of the constitutional functions of the executive or legislative departments,” (id. at 2612) and are “closely integrated into a public regulatory scheme[,]” (id. at 2613) while private rights relate to the “liability of one individual to another under the law as defined” (id. at 2612).

The Supreme Court previously held that a fraudulent transfer is more similar to a private right because fraudulent conveyance actions “are quintessentially suits at common law that more nearly resemble state-law contract claims brought by a bankrupt corporation to augment the bankruptcy estate than they do creditors’ hierarchically ordered claims to a pro rata share of the bankruptcy res.” Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 55-56 (1989). The Supreme Court in Stern applied that precedent and held that bankruptcy courts may not enter a final judgment on state law counterclaims that have not been resolved as part of a ruling on a creditor’s proof of claim, notwith - standing that the counterclaim is considered a “core” bankruptcy proceeding. Stern, 131 S. Ct. at 2620.

The District Court’s Decision

Although the Trustee brought the Avoidance Actions under SIPA rather than the Bankruptcy Code, the District Court concluded that avoidance actions under SIPA, just like those under the Bankruptcy Code, assert private rights, which are ordinarily reserved for final judgment by an Article III judge. The District Court supported its holding by noting that avoidance actions under SIPA share charac - teristics with claims that assert private rights because they: (i) are referred to bankruptcy courts rather than a regulatory agency, (ii) do not neces - sitate a final decision by a bankruptcy court to make SIPA’s statutory scheme “workable,” and (iii) generally do not include consensual submission to the adjudicative scheme (as is the case in SIPC v. Madoff, where the Avoidance Action defendants did not consent to the Bankruptcy Court's jurisdiction). The District Court noted, however, that a bankruptcy court may, in fact, have authority to finally resolve avoidance actions to the extent that it must decide a claim that raises the same issues as the avoidance action.

Although the District Court held that the Bankruptcy Court may not ordinarily enter final judgments on avoidance actions, it nevertheless determined that the Bankruptcy Court does have the judicial authority to hear the proceedings and recommend proposed findings of fact and conclusions of law to the District Court. The District Court reasoned that Congress would have wanted bankruptcy courts to exercise the lesser power it implicitly conferred on them—i.e., the power to propose findings of fact and conclusions of law. Finally, the District Court determined that it would not withdraw the reference “for cause shown” before the Bankruptcy Court issued its findings of fact and conclusions of law. In doing so, the District Court followed a growing trend based on other decisions in the district, as well as its own prior precedent, and took into account considerations of “efficiency” and “uniformity,” finding that the Bankruptcy Court’s report and recommendation would likely save both the District Court and the parties an “immense” amount of time.

Conclusion

In SIPC v. Madoff, the District Court provided some clarity on some of the outstanding issues concerning the authority of bankruptcy courts to hear and finally decide certain claims. relying on Stern, the District Court held that the Bankruptcy Court lacks authority to enter final judgments on pending Avoidance Actions. rather than withdrawing the reference and hearing the cases in the first instance, however, the District Court held that the Bankruptcy Court does have the judicial authority to hear the proceedings and recommend proposed findings of fact and conclusions of law. While the ultimate contours of Stern v. Marshall are still being determined, the SIPC v. Madoff case is consistent with the growing trend that while bankruptcy courts may ordinarily lack authority to finally decide avoidance actions, they may nevertheless hear such claims and submit proposed findings of fact and conclusions of law to the district court.