Back to Bankruptcy Court: District Court Denies Motion to Withdraw the Reference Even Though It Finds that Bankruptcy Court Lacked Authority to Finally Decide Claims

Contributed by Sara Coelho
Since the Supreme Court’s Stern v. Marshall decision, practitioners have speculated about how the decision would affect the bankruptcy court system and potentially slow down their cases.  Some district court judges may have secretly worried that the result of the Marshall family feud would be a flood of bankruptcy work on their dockets.  One recent district court decision offers a window on how district courts may manage these practical concerns where, following Stern, they find deficiencies in the bankruptcy court’s core jurisdiction.  In In re Canopy Financial, Inc., the District Court for the Northern District of Illinois, held that the bankruptcy court could not enter judgment on fraudulent conveyance and unjust enrichment claims, but it nevertheless denied a motion to withdraw the reference because it found that the bankruptcy court could still hear the claims.
In Canopy, a chapter 7 trustee commenced an adversary proceeding in the bankruptcy court asserting state and federal claims for fraudulent conveyance, as well as state claims for unjust enrichment.  The defendant moved to withdraw the reference of the case to the district court, arguing that the bankruptcy court lacked constitutional authority to decide the claims.  The district court agreed.  It found that the Supreme Court’s statements in Granfinanciera, S.A. v. Nordberg and in Stern regarding the nature of fraudulent conveyance suits as “quintessentially suits at common law” indicated that a bankruptcy court would “lack constitutional authority to enter final judgment on the claims presented here.”
The court found, however, that the Supreme Court “never suggested that bankruptcy courts could not otherwise hear those claims.”  It said that the “opposite” is suggested by a passage in Stern stating that the current system requires de novo review of all claims falling in the bankruptcy court’s related to jurisdiction, that the division of judicial labor won’t be changed much by its opinion, and that the appellant in Stern never challenged the bankruptcy court’s authority to hear counterclaims, just its authority to decide them.  Therefore, the court concluded that the Supreme Court “at least implied that the effect of its decision was to ‘remove’ certain claims from ‘core’ bankruptcy jurisdiction, and to relegate them to the category of claims that are merely ‘related to’ bankruptcy proceedings and thus subject to being heard, but not finally decided, by the bankruptcy courts.”
The court provided two interpretations of section 157 of the Judicial Code — the statute that defines core and related to bankruptcy proceedings — to support its conclusion.  First, it said that one can read Stern to remove claims from the bankruptcy court’s core jurisdiction when they would violate the constitution, and therefore leaves those claims in the bankruptcy court’s related to jurisdiction.  Second, one can read Stern to forbid the bankruptcy court from entering final judgment, but to allow the bankruptcy court to hear the matter by reading the Supreme Court as striking “and determine” from section 157 of the Judicial Code as it pertains to certain matters.  The court says that this interpretation leaves the statute without procedures for how the bankruptcy court would conduct such hearings, but says it is reasonable to interpret the bankruptcy court’s authority to hear such matters as being consistent with the procedures described in the statute for exercising related to jurisdiction.  The court found that it did not need to determine which of the explanations is “proper” because they lead to the same result.  Accordingly, it found that the bankruptcy court could hear the case and make proposed findings of fact and conclusions of law for submission to the district court, and it denied the defendant’s motion to withdraw the reference.  The case gives a vision of one of the practical solutions that district courts might employ to address situations where Stern issues arise.