Restructuring

Co-authored by Kyle J. Ortiz and Doron P. Kenter.
Last week, the Seventh Circuit Court of Appeals weighed in on the circuit split regarding bankruptcy courts’ authority to hear and determine “core” matters as to which they lack final constitutional authority.  Although we will bring you more on the Seventh Circuit’s decision in Wellness International Network v. Sharif in the coming weeks, we wanted to be sure to bring you prompt coverage of the latest and greatest in all things Stern.
As we’ve noted before, in Stern v. Marshall, the Supreme Court held that there are certain “core” bankruptcy matters as to which bankruptcy courts lack final adjudicatory authority (as a constitutional matter).  The broadest interpretation of Stern suggests that because bankruptcy courts are not “Article III” courts, they lack constitutional authority over any matters that are not either (i) couched squarely within the Bankruptcy Code or (ii) resolved in ruling on a claim against the debtor.
We’ve been following the circuit split regarding whether litigants can cure the constitutional deficiency through consent – in other words, whether bankruptcy courts can enter a final judgment on these “Stern” matters so long as the litigants have consented to such a resolution (a separate question involves whether consent may be implied from the parties’ conduct).  On August 21, the Seventh Circuit sided with the Sixth Circuit in holding that consent cannot cure such a constitutional deficiency.  The Seventh Circuit based its decision on many of the same principles as did the Sixth Circuit in Waldman, noting that Stern did not raise questions of subject matter jurisdiction (which is not waivable in any event), but instead called into question the structural division of authority between Article III courts and non-Article III courts, as contemplated by the Constitution.
More importantly, the Seventh Circuit questioned the current practice of many courts to resolve many of Stern’s questions by permitting appellate courts to “construe” orders of bankruptcy courts as reports and recommendations, subject to adoption by the district court should the district court determine the bankruptcy court lacked the constitutional authority to enter a final order.  The Seventh Circuit suggested that bankruptcy courts may not hear pretrial matters because there is no explicit statutory authorization for bankruptcy courts to hear such matters, as is the case with magistrate judges.  As the court wrote:

Assuming that the alter‐ego claim is in fact a core matter, it is difficult to find a statutory basis on which the district court could rely to treat the bankruptcy court’s order as proposed findings and conclusions.…[T]here is no statutory provision authorizing a bankruptcy court to preside over discovery, apart from its authority over core and noncore matters. It is true that magistrate judges often preside over pretrial matters such as discovery, even if the district court ultimately decides the claims for which discovery is sought, but 28 U.S.C. § 636(b)(1)(A) expressly authorizes a district judge to “designate a magistrate judge to hear and determine any pretrial matter pending before the court” . . . No analogous statutory authorization exists for bankruptcy judges. It appears, therefore, that if the alter‐ego claim is in fact a core proceeding, the only statutorily authorized remedy would be for the district court to withdraw the reference, see § 157(d), and then set a new discovery schedule. Of course, this would present a windfall to Sharif, but it is difficult to see any other solution under the peculiar circumstances of this case.

If this is the case, it would seem that if parties wish to litigate any matters falling into this “statutory gap,” the reference to the bankruptcy court must be immediately withdrawn – before motions to dismiss and before any discovery has taken place.
Keep following the Stern Files for more on Sharif and all things Stern, especially as we march toward further guidance from the Supreme Court (once it has considered Bellingham) regarding the “jurisdictional ping-pong” that Stern has precipitated over the past 26 months.
(PS: For those of you keeping score, it’s now the Ninth Circuit vs. the Sixth and Seventh Circuits. Very exciting indeed.)