The scenario has become all too familiar in recent years: a borrower defaults on a loan and, when the lender pursues the loan collateral through foreclosure or other proceedings, the borrower files for bankruptcy protection. More often than not, when the lender appears in bankruptcy court to pursue its interest in the collateral, the borrower counterattacks with a host of state law lender liability claims.

The recent opinion of the United States Supreme Court (the “Court”) in Stern v. Marshall (“Stern”), Case No. 10-179, 2011 WL 2472792 (U.S. June 23, 2011), may temper a borrower’s enthusiasm to pursue such claims. In Stern, the Court restricted a bankruptcy court’s jurisdiction to enter final judgments regarding claims arising under state law rather than the Bankruptcy Code. The Court held that a bankruptcy court, as a non-Article III court, lacks the constitutional authority to decide a state law claim brought by a debtor against a creditor, even if the matter is part of the “core” statutory jurisdiction of the bankruptcy court. This decision limits the reach of bankruptcy court jurisdiction and may require state law claims to be decided in a non-bankruptcy forum, even if they are central to a debtor’s bankruptcy case.  

The dispute in Stern arose out of litigation between Ms. Vickie Lynn Marshall (“Ms. Marshall”), also known as Anna Nicole Smith and Mr. Pierce Marshall (“Mr. Marshall”), the son of her former husband. After her husband’s death, Ms. Marshall filed for bankruptcy protection, and Mr. Marshall filed suit against her bankruptcy estate for defamation. Ms. Marshall counterclaimed for tortious interference with an expected gift from her late husband. The bankruptcy court rendered a final judgment on the counterclaim in Ms. Marshall’s favor. Mr. Marshall appealed the decision.  

On appeal, the Court questioned whether the bankruptcy court had both the constitutional and statutory authority to render a final judgment on the state law counterclaim. In the absence of either type of authority, the bankruptcy court would be unable to render a final judgment. Rather, it would only be permitted to offer suggested findings of fact and conclusions of law to the federal district court, which would then have the authority to review the matter de novo if any party objected. See 28 U.S.C. §157(c).

To determine whether bankruptcy courts have the requisite statutory authority, the Court reviewed 28 U.S.C. §157(b), which provides in pertinent part:

(b) (1) Bankruptcy judges may hear and determine all cases under Title 11 and all core proceedings arising under Title 11, or arising in a case under Title 11, referred under subsection (a) of this section, and may enter appropriate orders and judgments, subject to review under Section 158 of this Title.

(2) Core proceedings include, but are not limited to . . . .

(c) Counterclaims by the estate against persons filing claims against the estate. . . .

See 28 U.S.C. § 157(b)(2)(C) (emphasis supplied). Unanimously, the Court concluded that the state law tortious interference claim fell squarely within the statutory definition of a core proceeding because it was a counterclaim to the defamation claim and recognized that this finding would often end the jurisdictional inquiry:

In past cases, we have suggested that a proceeding’s “core” status alone authorizes a bankruptcy judge, as a statutory matter, to enter final judgment in the proceeding. See, e.g., Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989) (explaining that Congress had designated certain actions as “core proceedings,” which bankruptcy judges may adjudicate and in which they may issue final judgments. . . .)

Stern, 2011 WL 2472792, at *9.

The Court declined to end the analysis at this point, but went on to examine the bankruptcy court’s constitutional authority as a non-Article III court and, in a five-to-four ruling, held that the bankruptcy court lacked the constitutional authority to decide the state law counterclaim.

This ruling can be a powerful tool in a lender’s arsenal. Borrowers often attempt to assert a bevy of state law counterclaims in bankruptcy court, such as fraud, negligent misrepresentation, bad faith, promissory estoppel and duress and breach of contract, in attempts to forestall a lender’s pursuit of the loan collateral. Such claims will now call for heightened judicial scrutiny and make it more difficult for borrowers to obtain judgment on state law lender liability claims.