Restructuring

Contributed by Sara Coelho
Recently, we wrote about the United States Supreme Court’s decision in Stern v. Marshall, where the Court held by a 5 to 4 majority that the United States Constitution prohibits federal bankruptcy judges from entering a final judgment on a state law counterclaim asserted by a debtor where the counterclaim is not resolved in the process of ruling on the creditor’s proof of claim.  In Stern, the Court found that such determinations may only be made by judges who enjoy the privileges of lifetime tenure and salary protection provided by Article III of the Constitution.  The decision revives questions about the extent and nature of bankruptcy court jurisdiction, that many thought were resolved by the Court’s seminal 1982 decision on bankruptcy jurisdiction, Northern Pipeline Construction Company v. Marathon Pipe Line Company, and subsequent amendments to the bankruptcy jurisdiction statutes in 1984.  In this post, we explore the underpinnings of the Court’s decision, and some of its implications, in more detail.
Facts and Procedural History
The case arises from disputes over the inheritance of the late J. Howard Marshall II’s fortune.  Before Howard Marshall’s death, his wife, Vickie Lynn Marshall (better known as Anna Nicole Smith), filed a suit in Texas alleging that Howard Marshall’s son, E. Pierce Marshall, fraudulently induced Howard Marshall to cut Smith out of his estate.  Following Howard Marshall’s death, Smith filed for bankruptcy in California.  Pierce Marshall filed a claim against Smith in the bankruptcy case, asserting that Smith’s allegations of fraud defamed him, and an adversary proceeding seeking a determination that his defamation claim was not dischargeable in the bankruptcy.  Smith counterclaimed, alleging, among other claims, tortious interference with the gift she expected from Howard Marshall.  Under Federal Rule of Bankruptcy Procedure 7013, she was required to do so to the extent that her counterclaim was “compulsory.”
The bankruptcy court ruled against Pierce Marshall’s claim and in favor of Smith’s claim, and awarded Smith more than $425 million.  Appeals ensued.  In the meantime, the Texas state court issued a conflicting judgment in favor of Pierce Marshall.  The various appellate findings (including one by the U.S. Supreme Court) are not detailed here, except to say that, in the end, on remand, the Ninth Circuit found that Smith’s counterclaim was not a “core” proceeding that bankruptcy judges have the power to hear under section 157(b)(2)(C) of the Judicial Code because resolution of her claim was not necessary to resolve the claims asserted against her by Pierce Howard.  Although Smith had, by that time, passed away, her estate had continued the case.  The U.S. Supreme Court granted certiorari.
The Court’s Decision
The Court agreed with Smith that the bankruptcy court correctly applied section 157 of the Judicial Code, but it held that the Constitution requires that Smith’s common law claim be resolved by an Article III judge.  Under the U.S. Constitution, Article III defines the judicial power of the United States and prescribes that federal judges enjoy important salary and tenure protections designed to prevent the political branches from encroaching on the judicial power.  U.S. Const. Art. III, § 1.  Bankruptcy judges on the other hand, are appointed pursuant to Article I of the U.S. Constitution, which confers on the Congress the power to “establish . . . uniform Laws on the subject of Bankruptcies throughout the United States,” and do not enjoy constitutionally imposed salary and tenure protections.  U.S. Const. Art. I, § 8.  Citing Murray’s Lessee v. Hoboken Land & Improvement Co., 18 How. 272, 284 (1856), a 155-year-old Supreme Court decision, which states that “Congress may not ‘withdraw from judicial cognizance any matter which, from its nature, is the subject of a suit at the common law, or in equity, or admiralty,’” the Court found that Congress could not confer authority on a bankruptcy judge to resolve Smith’s state law counterclaim without violating the mandate of Article III of the Constitution because a non-Article III judge could not enter final judgment on claims like those asserted by Smith.  The Court further concluded that this result was consistent with the plurality opinion in Marathon, 458 U.S. 50 (1982), which found that a statute’s grant of jurisdiction to bankruptcy judges to issue final decisions on state law contract claims violated Article III, and the opinion of the majority in Marathon that (i) a public rights exception did not apply in that case, and (ii) the bankruptcy court was not acting as an adjunct of the district court.  The Court rejected arguments that Smith’s counterclaim could be resolved in the bankruptcy court under several alternate theories, which are discussed here in turn.
First, the Court found that any “public rights” exception to the requirement of Article III adjudications was not applicable and did not permit a bankruptcy court to adjudicate Smith’s claim.  In Murray’s Lessee, the Court described “matters, involving public rights, which may be presented in such form that the judicial power is capable of acting on them . . . but which congress may or may not bring within the cognizance of the courts of the United States, as it may deem proper.”  Such rights, the Court argued, are historically within the purview of the legislative or executive branches, which, in conferring such rights, have the power to determine whether those rights will be subject to adjudication before Article III courts or before a different tribunal, such as an administrative law judge.  Subsequent cases have expounded on this doctrine, but the Court maintained the doctrine has always been limited to cases where 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” and that public rights are “integrally related to particular federal government action.”  The Court held that Smith’s counterclaim did not resemble public rights under any of the precedent as it was not a “matter that could be pursued only by grace of the other branches.”  It also found that Smith’s counterclaim did not flow from any federal statutory scheme and that the bankruptcy court authority to decide Smith’s counterclaim was not limited to a particularized area of the law, as in an agency adjudication.
The Court similarly rejected the argument that the bankruptcy court had jurisdiction to decide Smith’s counterclaim as a result of Pierce Marshall having filed a proof of claim in Smith’s bankruptcy case.  The Court asserted that Pierce Marshall’s “decision to file a claim” should not “make any difference with respect to the characterization of [Smith’s] counterclaim.”  The majority opinion referred to and distinguished from the instant case previous cases that had permitted assertion of a preference action in the bankruptcy court against creditors that had filed proofs of claim because, among other things, in those cases, resolution of the preference actions had been necessary to resolve the disputed proofs of claim, and the actions brought had been created by federal bankruptcy law.  Thus, the Court continued the validity of bankruptcy court jurisdiction for certain counterclaims, particularly where such claims are grounded in the Bankruptcy Code.  Resolution of Smith’s counterclaim however, required rulings from the bankruptcy court on issues that the bankruptcy court did not need to determine in the course of allowing or disallowing Pierce Howard’s claim.
The Court also rejected the notion that the mandates of Article III were met because the bankruptcy court was operating as an “adjunct” of the district court.  It found that because the bankruptcy court “exercises the essential attributes of judicial power” and because it did not make “specialized” factual determinations in a particular area of law, but rather resolves “‘[a]ll matters of fact and law in whatever domains of the law to which’ the parties’ counterclaims might lead,” the bankruptcy court could not properly be viewed as an adjunct to another court.
The Court dismissed arguments that its ruling would lead to substantial additional cost and delay as unconvincing, and pointed to other kinds of state law claims that reside outside the bankruptcy court’s jurisdiction.  It so doing, the majority downplayed the potential effects of its decision stating, “[w]e do not think the removal of counterclaims such as [Smith’s] from core bankruptcy jurisdiction meaningfully changes the division of labor in the current statute; we agree . . . that the question presented here is a ‘narrow’ one.”
The Dissent
In the dissent, Justice Breyer, joined by justices Ginsburg, Sotomayor and Kagan, argued that the Court overstated the importance of Murray’s Lessee and Marathon, and failed to apply more recent precedent under which the Court has laid out factors to consider in determining whether a particular delegation of adjudicatory authority to a non-Article III judge encroaches on the judicial branch.  Such factors include the nature of the claim to be adjudicated and of the non-Article III tribunal, the extent of control over the proceeding by Article III courts, whether the parties consent, and the nature and importance of the legislative purpose served by the grant of adjudicatory authority to the non-Article III forum.  To the extent that the rights in question are “private rights,” a more “‘searching’ examination of the relevant factors” is required.  In weighing these factors under the Court’s precedent, Justice Breyer concluded that the “magnitude of any intrusion on the Judicial Branch can only be termed de minimis.”  (Internal quotations omitted).
Justice Breyer’s dissent also argued against the majority’s assertion that the effect of its decision would be minor, citing the frequency of similar disputes, the “staggering” volume of bankruptcy cases (approximately 1.6 million filings in 2010 compared with approximately 358,000 federal district court cases for the same period) and the fact that compulsory counterclaims are frequently premised on the same factual disputes as the claims asserted against bankruptcy estates that the bankruptcy courts are authorized to adjudicate.  He argued that a “constitutionally required game of jurisdictional ping-pong between courts would lead to inefficiency, increased cost, delay, and needless additional suffering among those faced with bankruptcy.”
Effects of the Decision
In addition to the logistical difficulties identified by the dissent, the Stern opinion raises numerous questions about a bankruptcy court’s jurisdiction in general, and how a debtor should assert its counterclaims in particular.  Most importantly, although the majority was careful to say that it was ruling on a narrow question, it will have to be seen how litigants and courts apply Stern’s reasoning.  In the case of state law counterclaims asserted by a debtor, it is not clear how procedures for referring those matters to the district court will evolve, or how claims presently being litigated will be treated.  In addition, the jurisdictional issue will, in some instances, be difficult for the bankruptcy court to determine at the outset of a case, and there may be cases where it becomes apparent that jurisdiction is lacking after substantial investment in the litigation by the parties.
Stern is not the first Supreme Court decision to raise substantial questions about the bankruptcy court’s power, however, and if past controversies are any guide, it will take time to fully understand its significance as the bankruptcy courts (and no doubt, Article III courts) grapple with its application.