Contributed by Doron P. Kenter.
On May 9, Judge Rakoff came down on the side of those who have argued that bankruptcy courts cannot enter a final judgment in fraudulent transfer actions, as such actions are not within the “stuff” of public rights. However, Judge Rakoff recognized that, notwithstanding the statutory scheme and constitutional limits on the authority of non-Article III judges, litigants should not move willy-nilly to withdraw the reference, as bankruptcy judges are still able to (and perhaps should) issue reports and recommendation in such actions.
In Kirschner v. Agoglia, the Trustee for the Refco Litigation Trust brought fraudulent conveyance and unjust enrichment claims against a number of defendants. With motions to dismiss pending, three of the defendants moved to withdraw the reference, which was granted for the limited purpose of addressing (i) whether the bankruptcy court could finally resolve the Trustee’s claims; and (ii) if the bankruptcy court could not finally resolve those claims, whether it could still issue proposed findings of fact and conclusions of law for the district court’s consideration.
After considering the parties’ arguments, Judge Rakoff first described the existing regime regarding bankruptcy courts’ authority. In relevant part, the court noted that 28 U.S.C. § 157 divides bankruptcy proceedings into (i) “core proceedings,” in which bankruptcy courts “may enter appropriate orders and judgments” and (ii) non-core proceedings, which bankruptcy courts may hear, but for which bankruptcy courts may only submit proposed findings of fact and conclusions of law, for the district court’s de novo review.
In Stern v. Marshall, the Supreme Court held that there are certain “core” proceedings in which bankruptcy courts do not have the constitutional authority to enter final judgments. In Stern, the Supreme Court concluded that bankruptcy courts may only enter a final judgment regarding (i) claims that are necessarily resolved in ruling on a creditor’s proof of claim and (ii) “public rights” claims – i.e., claims that assert rights derived from a federal regulatory scheme, which are therefore not the “stuff of traditional actions.”
In considering Stern’s effects on the Refco litigation, Judge Rakoff first turned to the procedural posture of the matter before the court. He noted that, even though the district court would apply de novo review to a decision on a motion to dismiss (regardless of whether it was a final order or a report and recommendation), a key distinction between the two forms of judgment still remained. Namely, a final order, even though it would be subject to de novo review on appeal, would be given res judicata and collateral estoppel effect, while a report and recommendation would not enjoy those effects.
Next, the court turned to the “heart” of Stern – i.e., the public vs. private rights distinction. Relying on Marathon, Granfinanciera, and Stern, the court held that fraudulent conveyance actions were “private rights” claims, in that they are “quintessentially suits at common law that more nearly resemble state law contract claims … than they do creditors’ hierarchically ordered claims to a pro rata share of the bankruptcy res.” (quoting Stern and Granfinanciera). Moreover, the court held that the Refco Trustee’s fraudulent conveyance claims would have no effect on the bankruptcy case and would simply increase payouts to creditors under the confirmed plan of reorganization. Still further, the court recognized that, even if consent could confer authority on the bankruptcy court (which it did not decide), the defendants in this action had not filed proofs of claim or otherwise consented to the court’s authority to enter a final judgment.
In concluding that bankruptcy courts lack constitutional authority to issue a final judgment in fraudulent conveyance actions, the district court rejected the oft-made arguments that the Supreme Court itself cautioned that Stern should be read “narrowly” and was not intended to upset the division of labor between the bankruptcy courts and Article III courts (a division of labor which, for several decades, had included final adjudication of fraudulent conveyance actions by the bankruptcy courts). Instead, the court concluded that “simple logic” dictated the court’s holding, and that “cautionary dicta and past practice do not overcome” the Supreme Court’s reasoning in Stern.
In addressing the second question before the court, Judge Rakoff recognized that nothing in the statutory scheme authorizes bankruptcy courts to issue reports and recommendation in core proceedings in which they lack authority to issue a final judgment (as opposed to non-core matters, in which they are expressly granted that authority). Notwithstanding that clear statutory gap, the court concluded that bankruptcy courts still could (and perhaps should) issue reports and recommendations in core matters in which they cannot issue a final judgment, as such a regime is (i) consistent with Congress’ clear intent that “whenever a bankruptcy court lacks the power to render a final judgment, it should render a report and recommendation” and (ii) perhaps not contingent upon statutory authority, as the district court can, and has, delegated such authority to the bankruptcy court.
Lastly, the court noted that withdrawal of the reference was, in any event, inappropriate under the circumstances. The bankruptcy court was already intimately familiar with the adversary proceeding, and was in a better position to reach a conclusion regarding the issues before it. Moreover, the court noted that “experience strongly suggests that having the benefit of the report and recommendation will save the district court and the parties an immense amount of time.” Though Judge Rakoff did not suggest that all fraudulent transfer actions should remain in the bankruptcy court unless and until a trial is necessary, litigants in fraudulent transfer actions would be well-advised to consider his recommendation when deciding the appropriate time to seek to withdraw the reference (if at all).