Restructuring

Co-authored by Kyle J. Ortiz and Doron P. Kenter.
On Tuesday, the Ninth Circuit Court of Appeals issued its long-awaited decision in In re Bellingham Insurance Agency, Inc., No. 11-35162 (9^th Cir. Dec. 4, 2012).  The Ninth Circuit held that, following Stern, bankruptcy judges – as “non-Article III judges” – lack constitutional authority to enter final judgments on fraudulent conveyance actions against third parties that are not claimants in the debtor’s bankruptcy case.  Significantly, however, the Ninth Circuit held that a failure to challenge the bankruptcy court’s authority at an earlier stage in the proceedings could constitute implied consent to final adjudication before the bankruptcy court.  This holding – that the right to have an action adjudicated before an Article III judge can be waived – is in direct contrast to the Sixth Circuit’s recent decision in Waldman v. Stone.  In Waldman, the Sixth Circuit held that parties cannot consent to final adjudication of matters as to which the bankruptcy court lacks authority to enter a final judgment, because that constitutional grant of authority is a nonwaivable “structural principle advanced by Article III.”
Background
The dispute in Bellingham arose when the chapter 7 trustee filed a complaint against a non-claimant third party, which the trustee alleged was a successor corporation of the debtor, and therefore liable for the debtor’s debts.  The trustee further alleged that the purported successor corporation was the beneficiary of various preferential and fraudulent transfers from the debtor prior to the commencement of the debtor’s bankruptcy case.
After the bankruptcy court granted summary judgment to the chapter 7 trustee, the defendant appealed to the district court, which affirmed the bankruptcy court’s judgment.  The defendant then appealed the district court’s judgment, and while that appeal was pending, the defendant filed a motion to vacate the bankruptcy court’s judgment in light of Stern, arguing that the bankruptcy court was constitutionally barred from entering a final judgment on the trustee’s claims.  The Ninth Circuit invited additional briefing on the point, and addressed Stern’s effect on the trustee’s underlying action.
Holding
In Bellingham, the Ninth Circuit explicitly held that Stern overruled the circuit’s long-standing precedent (arising from its 1987 In re Mankin decision) that core bankruptcy proceedings implicate public rights and are, thus, subject to the final authority of non-Article III bankruptcy courts.  The circuit court concluded that Stern, together with the Supreme Court’s decision in Granfinanciera, S.A. v. Nordberg, “point ineluctably to the conclusion that fraudulent conveyance claims, because they do not fall within the public rights exception [despite their statutorily core status], cannot be adjudicated by non-Article III judges.”
To explain its justification for overruling Ninth Circuit precedent without an en banc hearing, the court first stepped back to the Supreme Court’s 1982 Marathon decision, which stated that the only basis for allowing bankruptcy courts to render final judgments – notwithstanding the fact that they are not Article III courts – is where matters before the bankruptcy court involve “public rights.”  The Ninth Circuit noted that the Marathon Court “hinted that some quantum of bankruptcy proceedings might fall within the public rights exception” when it distinguished between the restructuring of debtor-creditor relations and the adjudication of state-created private rights.  The Ninth Circuit then stated that this distinction formed the basis for the core/non-core distinction enumerated by Congress in 28 U.S.C. § 157, originally enacted in 1984 in direct response to Marathon.
As a result of the understanding that core matters implicated public rights, while non-core matters related only to private rights (together with the Supreme Court’s decisions in Thomas v. Union Carbide Agricultural. Products Co. and Commodity Futures Trading Commission v. Schor), the Ninth Circuit concluded in Mankin that the “public rights exception was coextensive with” bankruptcy matters that have “been designated as ‘core’ by the 1984 Act.”
The Ninth Circuit in Bellingham acknowledged, however, that the case law following Marathon cast doubt on this understanding of the dichotomy between core and non-core matters, and that certain cases seemed to undermine the circuit’s precedent in Mankin.  Chief among those cases was the Supreme Court’s decision in Granfinaciera, which stated that a fraudulent conveyance action is “more accurately characterized as a private rather than a public right.”  Prior to Stern, the circuit was able to satisfy itself that Granfinanciera was not at odds with Mankin because Granfinanciera addressed parties’ constitutional right to a trial by jury (in the district court), but did not address the nature of the bankruptcy court’s authority (other than its ability to conduct a jury trial).  In Stern, however, the Supreme Court explained that the state law counterclaims at issue were indistinguishable from the fraudulent conveyance claim in Granfinanciera (despite the fact that a jury trial was not implicated in any way).  In light of the Supreme Court’s holding that bankruptcy courts lack authority to enter a final judgment regarding certain core claims that do not necessarily implicate a jury trial, the Ninth Circuit stated that it could “no longer resist Granfinanciera’s logic,” and held that, because fraudulent transfer claims against non-claimants do not implicate “public rights,” they cannot be finally adjudicated by a non-Article III court.  The court noted that this decision was required in light of existing Supreme Court precedent (and that it was not overruling Mankin because the Supreme Court had effectively done so in Granfinanciera and Stern).
Notably, the Ninth Circuit was quick to observe that its decision is not inconsistent with the Sixth Circuit’s Onkyo decision, in which the Sixth Circuit held that bankruptcy courts have constitutional authority to enter final judgments in fraudulent transfer actions, because in Onkyo, the creditor-defendant had filed a proof of claim against the debtor, and resolution of the fraudulent transfer action was necessary to resolving the creditor’s underlying proof of claim.
To the Ninth Circuit, this distinction – namely, whether a resolution of the fraudulent conveyance action is necessary to resolve a proof of claim – is critical in determining whether a non-Article III court has constitutional authority to decide a fraudulent conveyance action.  Based on that distinction, the Bellingham court rejected the arguments made in several amicus briefs asserting that a bankruptcy court had final authority based on the Supreme Court’s decision in Katchen v. Landy (holding that bankruptcy referees had summary jurisdiction over preference actions).  The Ninth Circuit found those arguments unpersuasive because Katchen, unlike Stern and Granfinanciera “involved a claim against a creditor that necessarily had to be resolved in the course of the claims-allowance process, and Stern and Granfinanciera did not.”  This distinction is consistent with the two-prong test referenced in Stern (and favored by many courts), which provides that bankruptcy courts have constitutional authority to enter a final judgment where “the action at issue [(i)] stems from the bankruptcy itself or [(ii)] would necessarily be resolved in the claims allowance process.”  If either prong is met, the bankruptcy court necessarily has final adjudicatory authority over the matter before the court.
Reports and Recommendations Permissible
Notwithstanding its holding that non-claimant defendants in fraudulent transfer actions are entitled to a final judgment from an Article III court, the Ninth Circuit considered whether bankruptcy courts may still “hear” such claims and prepare recommendations (for de novo review) by the district courts.  The court observed that 28 U.S.C. § 157(c) explicitly authorizes bankruptcy judges to submit proposed findings of fact and conclusions of law in non-core proceedings, but held that, because 28 U.S.C. § 157(b)(1) “empowers bankruptcy courts to ‘hear and determine’ fraudulent conveyance claims in a manner consistent with the strictures of Article III,” bankruptcy courts necessarily retain “the more modest power to submit findings of fact and recommendations of law to the district courts.”  In other words, regardless of their lack of constitutional authority over fraudulent transfer actions (and, presumably, certain other core matters as to which they lack such authority), bankruptcy courts may still hear any such matters through to a preliminary resolution – though any proposed findings of fact issued in such a proceeding would be subject to de novo review by the district court (bankruptcy courts’ conclusions of law would be subject to de novo review in any proceeding).
Article III Adjudication Is Waivable
After determining that a non-claimant defendant in a fraudulent transfer action has the right to obtain a final judgment from an Article III court, the Ninth Circuit turned to the question of whether that right is waivable.  Contrary to the Sixth Circuit’s recent decision in Waldman, the Ninth Circuit held that the right to final judgment from an Article III court is, in fact, waivable.  Quoting Schor, the Ninth Circuit noted that an independent judiciary “serves to protect primarily personal, rather than structural interest” and that accordingly, as a personal right (rather than a structural right, such as the nature and extent of a court’s subject matter jurisdiction), the constitutional “guarantee of an impartial and independent federal adjudication is subject to waiver.”
By contrast, in Waldman,  the Sixth Circuit (also citing Schor), stated that any shift of judicial powers to non-Article III judges necessarily makes the “Judicial Branch … weaker and less independent than it is supposed to be.”  Thus, the Sixth Circuit held that an objection to the bankruptcy court’s final authority implicates “the structural principle advanced by Article III.”
In apparent response to this understanding of Schor (but without acknowledging the Sixth Circuit’s discussion of this point in Waldman), the Ninth Circuit acknowledged in a footnote that the Court in Schor expressed concern about “the encroachment or aggrandizement of one branch at the expense of the other.”  However, the Ninth Circuit distinguished Schor on this point, observing that Schor involved adjudication by an Executive Branch agency, whereas bankruptcy judges “are officers of the district court and are appointed by the Courts of Appeals,” which necessarily creates less concern about encroachment on the judiciary.  (This begs the question: Does Bellingham suggest that non-Article III judges are a part of “the judiciary,” notwithstanding the extensive distinction drawn between the two courts in Stern?)
Though the Ninth Circuit addressed the essential “gist” of the Sixth Circuit’s holding in Waldman, the Bellingham court failed to address directly the fact that its holding was at odds with the Waldman court’s holding that constitutional authority is “structural” and, therefore, that parties cannot waive their rights to final judgment in an Article III court in matters as to which the bankruptcy court lacks final authority.  Thus (perhaps without even realizing it), the Ninth Circuit created the first clear circuit split on the question of whether a party can waive its right to final judgment from an Article III court where the bankruptcy court otherwise lacks authority to enter a final judgment.
Postscript: The Defendant Impliedly Waived Its Right to Final Adjudication Before an Article III Court
In any event, after holding that parties’ rights to final judgment from an Article III court in core matters as to which bankruptcy courts lack final authority are subject to waiver, the court concluded that, regardless of the limits on bankruptcy courts’ authority, the defendant in Bellingham had, in fact, impliedly waived its right to final judgment from an Article III court because it had failed to assert the right at an early stage of the proceeding before the bankruptcy court.  Notably, had the Bellingham court not found waiver, the bankruptcy court still could have entered findings of fact and conclusions of law.  Given the ruling on waiver, the court did not ultimately reach this issue. (This begs the questions: if the only ultimate distinction is the level of review applied by the district court to the bankruptcy court’s proposed findings of fact, is there any reason to assert Article III rights at an early stage of the proceeding, other than to preserve a potentially favorable standard of appellate review?  If the defendant in Bellingham waived its right to final adjudication by an Article III court, is the Ninth Circuit’s Stern discussion simply dicta?)