In a decision that may create serious problems for bankruptcy case administration, the Supreme Court this morning invalidated part of the Bankruptcy Court jurisdictional scheme. Stern v. Marshall, No. 10-179, 564 U.S. ___ (June 23, 2011). Specifically, the Court held that the Bankruptcy Courts cannot issue final judgments on garden variety state law claims that are asserted as counterclaims by the debtor or trustee against creditors who have filed proofs of claim in the bankruptcy case.
Thus, while the Bankruptcy Court could issue a final order resolving the creditor’s claim against the estate, it could issue only a proposed ruling with respect to the counterclaim. Final judgment on the counterclaim could only be issued by the District Judge after de novo review of any matters to which a party objects. See 28 U.S.C. § 157(c).
In a five-to-four opinion by Chief Justice Roberts, the Court affirmed the Ninth Circuit Court of Appeals decision that had reversed an $88 million judgment in favor of Vickie Lynn Marshall (a/k/a Anna Nicole Smith) against E. Pierce Marshall for tortious interference with Vickie’s expectancy of a gift from her late husband J. Howard Marshall, Pierce’s father and one of the richest people in Texas.
The Court’s decision was based on constitutional principles defining the limits of Article III of the U.S. Constitution. Thus, it is likely to have implications that reach far beyond the narrow issue resolved in the instant case. The majority relies on the "public rights" doctrine to define the class of judicial matters that can be resolved by non-Article III tribunals like the Bankruptcy Courts. However, it adopts a narrower view of what constitutes "public rights" than was generally understood prior to this decision.
In addition, although earlier cases could be read to adopt a flexible pragmatic approach to Article III that focused only on significant threats to the Judiciary, Chief Justice Roberts takes a very firm approach, stating, "We cannot compromise the integrity of the system of separated powers and the role of the Judiciary in that system, even with respect to challenges that may seem innocuous at first blush." Of particular interest, this case focuses on the nature of the Bankruptcy Judge as a non-Article III judge (i.e., no life tenure and no salary protection) and rejects the view that the Bankruptcy Courts are merely "adjuncts" of the Article III District Courts. Note that the "adjunct" construct was one of the foundations of the 1984 Act's post-Northern Pipeline jurisdictional fix that created the core/non-core distinction. See Northern Pipeline Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982).
The narrow holding is that Bankruptcy Judges, as non-Article III judges, lack constitutional authority to hear and "determine" counterclaims to proofs of claim if the counterclaim involves issues that are not essential to the allowance or disallowance of the claim. Here, although the counterclaim was a compulsory counterclaim, it was a garden variety state law tort claim and did not constitute a defense to the proof of claim. Contrast this with the preference claim involved in Langenkamp v. Culp, 498 U.S. 42 (1990). The receipt of such an unreturned preference is a bar to the allowance of the claim. See 11 U.S.C. 502(d). The opinion also distinguishes Langenkamp (and the earlier pre-Code case of Katchen v. Landy, 382 U.S. 323 (1966)) on the ground that the preference counterclaims in those cases were created by federal bankruptcy law. It is unclear whether that reference establishes a second condition to Bankruptcy Court resolution of counterclaims — i.e., that the counterclaim be based on bankruptcy law in addition to its resolution being essential to claim allowance.
The Court begins its opinion by interpreting the "core" jurisdictional grant of 28 U.S.C. 157(b)(1). The Court finds the provision ambiguous, but rejects the view of the Ninth Circuit that the Bankruptcy Court's jurisdiction to determine matters involves a two-step process of deciding both whether the matter is "core" and whether it "arises under" the Bankruptcy Code or "arises in" the bankruptcy case. The Court states that such a view incorrectly assumes there are "core" matters that are merely "related to" the bankruptcy case (and which cannot be "determined" by the Bankruptcy Court). The Court states that core proceedings are those that arise in a bankruptcy case or arise under bankruptcy law and that noncore is synonymous with "related." Thus, since counterclaims to proofs of claim are listed as core in the statute, the Bankruptcy Court has statutory authority to enter final judgment. (Note that the opinion does not explain how a tort claim that arose before the bankruptcy and that was based on non-bankruptcy state law could be a claim "arising in" the bankruptcy case or "arising under" bankruptcy law. Possibly the fact that procedurally it arises as a counterclaim is sufficient to convert a "related" claim into an "arising in" or "arising under" claim. Cf. Langenkamp.)
The Court also rejects the argument that the personal injury tort provision of 28 U.S.C. 157(b)(5) deprives the Bankruptcy Court of jurisdiction to resolve the counterclaim. The Court holds that section 157(b)(5) is not jurisdictional and thus the objection was waived.
Although the statute authorized the Bankruptcy Court to determine the counterclaim, the Court holds that grant violates Article III. The Court rejects the view that the Article III problem was resolved by placing the Bankruptcy Judges in the judicial branch as an "adjunct" to the District Court. The Court focuses on the liberty aspect of Article III and its requirement of judges who are protected by life tenure and salary guarantees. After outlining the extensive jurisdiction of Bankruptcy Judges over matters at law and in equity and their power to issue enforceable orders, the Court states "a court exercising such broad powers is no mere adjunct of anyone."
The Court then uses the "public rights" doctrine as the test for which matters can be delegated to a non-Article III tribunal. Although Granfinanciera v. Nordberg, 492 U.S. 33 (1989), suggested a balancing test that considered both how closely a matter was related to a federal scheme and the degree of District Court supervision (a test that arguably supports the Bankruptcy Court's entry of a judgment on a compulsory counterclaim), the Court settles on a new test for public rights limited to "cases in which resolution of the claim at issue derives from a federal regulatory scheme, or in which resolution of the claim by an expert government agency is deemed essential to a limited regulatory objective within the agency's authority." The state common law tort counterclaim asserted here does not meet that test. Instead, adjudication of this claim "involves the most prototypical exercise of judicial power."
Interpreted in the most restrictive fashion, this ruling might create serious problems for case administration. In proof of claim matters, the Bankruptcy Court would be limited to proposed findings on most counterclaims, with the District Court entering the final order after de novo review. Query whether the majority's limited view of "public rights" would prevent the Bankruptcy Judge from entering final judgment in other disputes that involve the non-bankruptcy rights of non-debtor parties. Bankruptcy Courts regularly resolve inter-creditor disputes and resolve disputes regarding the non-bankruptcy rights of parties to the bankruptcy case in contexts other than claim allowance. Whether the Bankruptcy Court’s exercise of this power is constitutional may turn on how broadly the courts interpret the "cases in which resolution of the claim at issue derives from a federal regulatory scheme" prong of the "public rights" test.