i consent [to the bankruptcy court hearing] – not so...

I Consent [To the Bankruptcy Court Hearing] – Not So Fast!!!

A Webinar of the Business Bankruptcy Committee of the Business Law Section of the American Bar Association

Tuesday, November 27, 2012 1:00 p.m. (Eastern)

Hon. Barbara Houser, Chief Judge for United States Bankruptcy

Court for the Northern District of Texas Professor Kenneth N. Klee, UCLA School of Law and Partner,

Klee, Tuchin, Bogdanoff and Stern, LLP Judith Greenstone Miller, Partner, Jaffe, Raitt, Heuer & Weiss, P.C.

© 2012 All Rights Reserved*

* The material contained in this power point presentation in a revised format has been reproduced with permission. It was previously used in connection with (i) a Joint Presentation of the Bankruptcy Committee of the Federal Bar Association for the Eastern District of Michigan and the Debtor/Creditors’ Rights Committee of the Business Law Section of the State Bar of Michigan on September 20, 2011 by the Hon. Thomas J. Tucker, U.S. Bankruptcy Court, E.D. Michigan, Professor John A.E. Pottow, University of Michigan, Michael S. Leib, Shareholder, Maddin, Hauser, Wartell, Roth & Heller, P.C. and Judith Greenstone Miller, Shareholder, Jaffe, Raitt, Heuer & Weiss, P.C.; (ii) a Presentation of the Business Bankruptcy Committee of the Business Law Section of the ABA on September 27, 2011 by Richard Levin, Cravath, Swaine & Moore LLP, Kenneth N. Klee UCLA School of Law and Klee, Tuchin, Bogdanoff & Stern LLP, Hon. Barbara Houser., U.S. Bankruptcy Judge, N.D. Texas, and Prof. Richard Lieb, St. John’s University School of Law and Retired Partner, Cooley LLP; (iii) a Presentation of the Commercial Law League of America and its Bankruptcy Section on October 4, 2011 by Craig K. Goldblatt, Wilmer Cutler Pickering Hale an Dorr LLP, Kenneth N. Klee, UCLA School of Law and Klee, Tuchin, Bogdanoff & Stern LLP, Judith Greenstone Miller, Jaffe, Raitt, Heuer & Weiss, P.C. and Stephen W. Sather, Barron, Newburger & Sinsley, PLLC; and (iv) a Presentation of the American Bankruptcy Institute on June 8, 2012 at the Central States Bankruptcy Workshop by Hon. Thomas J. Tucker, United States Bankruptcy Judge, E.D. Mich., Professor John A.E. Pottow, University of Michigan, Michael S. Leib, Maddin, Hauser, Wartell, Roth & Heller, P.C., Jeffrey A. Marks, Vorys, Sater, Seymour and Peace LLP and Judith Greenstone Miller, Jaffe, Raitt ,Heuer & Weiss, P.C.

1

Pre-1978 Jurisdiction and Authority of the Bankruptcy Court

• U.S. District Court served as Bankruptcy Court and employed a referee system.

• Bankruptcy proceedings were generally conducted before referees.

• Bankruptcy Court had “summary jurisdiction” over controversies involving property in the actual or constructive possession of the court.

• With consent, the Bankruptcy Court had jurisdiction over “plenary” matters such as disputes involving property in the possession of a third person.

2

Jurisdiction and Authority of the Bankruptcy Court

• The structure of jurisdiction and authority of the bankruptcy court under the Bankruptcy Code in 1978

• 28 U.S.C. § 1334 • 28 U.S.C. § 157

3

The Plurality Decision in Marathon

Northern Pipeline Construction Co. v. Marathon Pipeline Company, 458 U.S. 50 (1982) • The Bankruptcy Court pursuant to the Bankruptcy Act of 1978, had

jurisdiction over all “civil proceedings arising in or related to cases under Title 11.”

• This meant the Bankruptcy Court could entertain a wide variety of cases

involving claims that affected property of the estate, suits to recover accounts, actions to avoid transfers, preferences, fraudulent conveyances, and causes of action owned by the Debtor at the time the bankruptcy petition was filed.

4

The Plurality Decision in Marathon • The question plainly put by the Supreme Court for determination was: “Whether the Bankruptcy Act of 1978 violates the command of Art. III that

the judicial power of the United States must be vested in courts whose judges enjoy the protections and safeguards specified in that Article.” 458 U.S. at 62.

• The Court held that 28 U.S.C. §1471, as added by §241(a) of the

Bankruptcy Act of 1978, impermissibly removed most, if not all, of “the essential attributes of the judicial power” from Art. III district court, and has vested those attributes in a non-Art. III adjunct. Such a grant of jurisdiction cannot be sustained as an exercise of Congress’ power to create adjuncts to Article III Courts.

• Art. III bars Congress from establishing legislative courts to exercise

jurisdiction over all matters related to those arising under the bankruptcy laws.

5

The 1984 Amendments and Post-Marathon Jurisdiction

• After Marathon and the 1984 Amendments (Bankruptcy Amendments and Federal Judgeship Act of 1984) enacted to, among other things, address Marathon, practitioners believed that the Article III infirmities addressed in Marathon had been resolved. As a result of Katchen v. Landy, 382 U.S. 323 (1966), most believed, broadly, that the Bankruptcy Court was a court of equity and, but for limited exceptions in 28 U.S.C. 1411, jury trials were not permitted in the Bankruptcy Court.

• In Katchen v. Landy, 382 U.S. 323, 337 (1966) – the filing of a proof of claim

constitutes consent to the adjudication of all claims associated with the claims allowance process under section 57g of the Act involving the disallowance of a claim until preference recoveries are returned to the estate. The Court also stated that there was "...no Seventh Amendment right to a jury trial."

6

The Ruling in Langenkamp

Langenkamp v. Culp, 498 U.S. 42 (1990) (per curiam): “[O]nce the court determines the voidability of the preference, nothing remains for adjudication in a plenary suit.” Thus, by determining the voidability of the claim, the bankruptcy court could enter a final judgment on the preference.

7

The Ruling in Granfinanciera Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989) The Trustee sought to recover a fraudulent conveyance under section 548 of the Bankruptcy Code. The question presented is: “Whether a person who has not submitted a claim against the bankruptcy

estate has the right to a jury trial when sued by the bankruptcy trustee in bankruptcy to recover an allegedly fraudulent monetary transfer.”

The holding is: The Seventh Amendment entitles such a person to a jury trial even if

Congress designated a fraudulent conveyance action as a core proceeding.

8

The Ruling in Granfinanciera

The Court determined that a fraudulent conveyance action is one at law, for which a jury trial is appropriate and petitioners were entitled to a jury trial. The Seventh Amendment command could not be overcome merely because the lawsuit was brought in the Bankruptcy Court.

The Court did not decide whether the jury trial provision – 28 U.S.C. §

1411 – permitted the Bankruptcy Court to conduct a jury trial in fraudulent conveyance actions or whether the Seventh Amendment or Article III allowed jury trials in such actions to be held before a non-Article III Bankruptcy Judge.

9

The Ruling in Schor Commodity Futures Trading Com’n. v. Schor, 478 U.S. 833 (1986) – the Court held

that the Commodity Exchange Act (“CEA”), that empowered the Commodity Futures Trading Commission (“CFTC”) to entertain state law counterclaims in reparation proceedings was reasonable and did not encroach upon or violate Article III of the Constitution because:

(i) by seeking reparations under the CEA, the parties had forgone or waived their right to an Article III judge,

(ii) the CFTC exercises only limited jurisdiction over class of state law claims as a necessary incident to the adjudication of federal claims, thereby not impermissibly threatening the institutional integrity of the Judicial Branch, and

(iii) federal courts can and do exercise ancillary jurisdiction over state law counterclaims and having a federal agency, rather than a federal Article III court hear the state law claim, was not objectionable as there was “no historical support for the critical link [Schor] posits between the provisions of Article III that protect the independence of the federal judiciary and those provisions that define the extent of the judiciary’s jurisdiction over state aw claims.”

10

The Supreme Court Cases

Finally, it is important to note that: Katchen v. Landy, Commodity Futures Trading Com’n. v. Schor

and Langenkamp v. Culp were all cited by the Majority in the Stern v. Marshall decision, the analysis and holding of which follows.

11

The Holding of the Supreme Court in

Stern v. Marshall, 131 S.Ct. 2594 (2011) The Court held that:

(i) The bankruptcy court had the statutory authority under 28 U.S.C. § 157(b)(2)(C) to enter a final judgment on Vicki’s counterclaim as a core proceeding because it arose in a bankruptcy case or arose under the Bankruptcy Code.

(ii) By filing a proof of claim and actively litigating in the bankruptcy court, Marshall had consented to the bankruptcy court entering a final judgment on the proof of claim under 28 U.S.C. § 157(b)(5), including those matters under Section 502(d) of the Bankruptcy Code.

(iii) Deemed consent through litigating a proof of claim, however, does not constitute consent to have the bankruptcy court enter final judgment on a counterclaim unless it “stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.”

(iv) The bankruptcy court lacks the ability to make a final determination on the counterclaim as a matter of constitutional law.

(v) Section 157(b)(5) is not jurisdictional and can be waived.

12

The Rationale of the Majority In reaching this decision, the majority of the Court set forth numerous

different reasons why an Article III judge was required to adjudicate the counterclaim. These included the following:

a. Article III of the U.S. Constitution does not allow a bankruptcy

court to make a final determination on claims that arise solely as a matter of common law, equity or admiralty law.

--The counterclaim in this case – tortious interference with a gift or

expectancy – clearly fell under the State common law and, thus, it must be finally determined by an Article III judge.

--The counterclaim was not related to or arising under a particular

provision of the Bankruptcy Code.

13

The Rationale of the Majority

b. The counterclaim was not completely derived from or dependent upon adjudication of a claim created by federal bankruptcy law; nor did it “stem from the bankruptcy itself or would necessarily be resolved in the claims allowance process.”

--According to Chief Justice Roberts: “Congress may not bypass Article III

simply because a proceeding may have some bearing on a bankruptcy case; the question is whether the action stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.”

c. There was never any reason to believe that the process of

adjudicating Pierce’s proof of claim would necessarily resolve Vickie Lynn’s counterclaim.

14

The Rationale of the Majority d. Article III of the U.S. Constitution vests the judicial power with

Article III judges who have life tenure and salary guarantees and, as part of the judicial branch (as opposed to Article I bankruptcy judges created through the legislative branch), are protected from undue political influence from the legislative and executive branches, thereby providing litigants with judges that are neutral and free from such influence. There was no room for any approach that would “chip away” at Article III jurisdiction.

e. Pierce did not truly consent to the resolution of Vickie Lynn’s

claim in the bankruptcy proceeding and the filing of a proof of claim did not constitute consent to jurisdiction. After all, according to the Court, “[h]e had nowhere else to go [to assert his claim] if he wished to recover from Vickie’s estate.” How a proof of claim is characterized is not binding or determinative of how a counterclaim is viewed.

15

The Rationale of the Majority

f. Vickie Lynn’s counterclaim did not fit within the “public rights” historical exception to Article III jurisdiction, under which Congress could constitutionally assign certain limited matters to “ legislative” courts for resolution.

--First, the counterclaim did not stem or flow from a federal statutory

scheme or depend on the will of Congress. --Second, it was not limited to a particularized area of law in which

Congress had devised an administrative agency particularly suited to examine and determine the issue.

16

The Rationale of the Majority g. The Bankruptcy Court is not an adjunct of the district court so as to

give it the right to make final determinations in areas reserved to an Article III judge.

--The fact that a bankruptcy court is a court of equity is not per se

sufficient to deprive a litigant of an Article III court. --The bankruptcy judge had the power to enter appropriate orders and

judgments – including final judgments – subject to review only if a party chooses to appeal.

17

The Rationale of the Majority h. The Supreme Court makes a distinction between those actions

that involve “administration of the estate” versus “augmentation of the estate.”

--If the matter at issue relates to the administration of the estate, apparently, it falls within the core jurisdiction of the bankruptcy court to adjudicate on a final basis.

--If, however, the matter relates to “augmentation of the estate” – in other words, bringing in assets in the estate through a fraudulent conveyance, preference or other recovery – the Court’s holding could be read to suggest that absent consent of the parties, the bankruptcy court cannot make a final determination but rather must make recommendations to the district court.

--According to Judge Hughes, Bankruptcy Judge for the United States Bankruptcy Court for the Western District of Michigan, such actions require an Article III judge because they involve the “taking of property” under the Fifth Amendment to the U.S. Constitution. See In re Teleservices Group, Inc., 2011 WL 3610050 (Bankr. W.D. Mich. 2011) at p. 17.

18

Justice Scalia’s Concurring Opinion Justice Scalia wrote that “an Article III judge is required in all federal

adjudications, unless there is a firmly established historical practice to the contrary,” as the sole basis for his ruling. He further dismissed the need to set forth alternative or multiple bases for the ruling, as had been done by the majority.

While he recognized that Article III judges are not required in the context

of territorial courts, court-martial or true “public rights” cases and “[p]erhaps historical practice permits non-Article III judges to process claims against the bankruptcy estate, . . . Vickie points to no historical practice that authorizes a non-Article III judge to adjudicate a counterclaim of the sort at issue here.”

19

The Dissenting Opinion Justice Breyer concluded that the “grant of authority to a bankruptcy

court to adjudicate compulsory counterclaims does not violate any constitutional separation of powers principle related to Article III.”

Justice Breyer criticized the manner in which the majority interpreted, or

at least emphasized certain precedents of the Court. Moreover, the presence of “private rights,” according to Justice Breyer, did not automatically determine the outcome of the question but rather requires a more searching examination of the relevant factors.

While Justice Breyer noted and recognized that the nature of the claim at

issue poses a heightened risk of encroachment on the Federal Judiciary, that factor was mitigated here by the fact that the bankruptcy courts often decide claims that similarly resemble various common-law actions.

20

The Dissenting Opinion The focus, according to Justice Breyer, should be on “the substance rather

than on doctrinal reliance on formal categories.” The nature of the non-Article III tribunal also argued in favor of

constitutionality because the tribunal is made up of judges who enjoy considerable protection from improper political influence. Moreover, bankruptcy judges are functionally the same as magistrate judges, law clerks and the Judiciary’s administrative official, whose lack of Article III tenure and compensation protections do not endanger the independence of the Judicial Branch.

The control exercised by Article III judges over bankruptcy proceedings ,

through such things as the ability to withdraw, in whole or in part, any case or proceeding referred to the bankruptcy court, favor a finding of constitutionality.

21

The Dissenting Opinion The parties consented to bankruptcy jurisdiction, thereby supporting

constitutionality. Justice Breyer took issue with the majority for finding otherwise. Pierce not only filed a proof of claim but also actively participated in the bankruptcy proceedings.

The nature and importance of the legislative purpose served by the grant

of adjudicatory authority to bankruptcy tribunals argued in favor of a finding of constitutionality. In this regard, Justice Breyer relied on Article I, § 8 of the Constitution – the power to establish uniform laws on bankruptcy. To be effective, a single tribunal must have broad authority to restructure those relations and controversies that come before it.

Finally, the dissent urged a pragmatic approach and pointed to the

practical difficulties and increased time and expense that will flow from the majority’s opinion.

22

Questions Not Answered by the Supreme Court Opinion

--Can you consent to bankruptcy court authority to enter final judgments and, if so, how?

--If the filing of a proof of claim is not sufficient to waive your objection to the authority of the bankruptcy court to enter a final judgment, what is necessary to do so?

--Does the ruling result in a de facto overruling of Gardner v. New Jersey, 329 U.S. 565 (1947) (when a sovereign files a claim against a debtor in bankruptcy, the sovereign waives immunity with respect to adjudication of the claim)? What is the impact of suing a governmental entity on an avoidance action when the governmental entity has filed a proof of claim?

--Does the bankruptcy court have the authority to make final determinations on a chapter 5 cause of action (i.e., preference, fraudulent conveyance under Sections 544, 547, and 548, post-petition transfer under Section 549)? Does it matter whether a right to jury trial is requested?

23

Questions Not Answered by the Supreme Court Opinion

--Is the constitutional authority of the bankruptcy court limited solely to those matters that relate to “the administration of the estate” as opposed to “the augmentation of the estate?”

--What counterclaims can a bankruptcy judge, as opposed to an Article III

judge, adjudicate? --What is a “public right” versus a “private right?” --Under Section 558 of the Bankruptcy Code, the estate can assert the

defenses of the debtor to defeat a claim. If the defense is setoff/recoupment, is the determination of the bankruptcy court binding when the counterclaim is subsequently raised in a state or district court?

24

The Rulings of the Appellate Courts

Technical Automation Services Corp. v. Liberty Surplus Insurance Corporation, 673 F.3d 399 (5th Cir. 2012): • Court of Appeals sua sponte raised the question of

whether Article III of the Constitution permits a federal magistrate judge, with the consent of the parties, to enter final judgment of a party’s state law counterclaims under the Federal Magistrates Action pursuant to 28 U.S.C. § 636(c)(1)

25

The Rulings of the Appellate Courts 28 U.S.C. § 636(c)(1) provides: “Upon the consent of the parties, a full-time United States magistrate judge or a part-time magistrate judge who serves as a full-time judicial officer may conduct any or all proceedings in a jury or nonjury civil matter and order the entry of judgment in a case, when specially designated to exercise such jurisdiction by the district courts or courts he serves. Upon the consent of the parties, pursuant to their specific written request, any other part-time magistrate may exercise such jurisdiction, if such magistrate judge meets the bar membership requirements set forth in section 631(b)(1) and the chief judge of the district court certifies that a full-time magistrate judge is not reasonably available in accordance with guidelines established by the judicial counsel of the circuit. When there is more than one judge of a district court, designation under this paragraph shall be by the concurrence of a majority of all the judges of such district court, and when there is no such concurrence, then by the chief judge.” (Emphasis added)

26

The Rulings of the Appellate Courts • The court examined the holding of Stern v. Marshall

and held that it did not, sub silentio, overrule prior precedent of the circuit allowing magistrate judges such authority, particularly when the Supreme Court had repeatedly emphasized that Stern had very limited application.

• This ruling was made by the court despite their finding that the existence of similarities between bankruptcy judges and magistrate judges that might otherwise suggest that the court’s analysis in Stern could be extended in this case.

27


• The court buttressed its opinion on the fact that the Magistrates Act not only required consent of the parties but also permits the district court to vacate the reference to the magistrate on its own motion, thereby curing any constitutional infirmity that might otherwise exist.

28

The Rulings of the Appellate Courts Global Technovations, Inc. v. Onkyo USA (In re Global Technovations, Inc.), 694 F.3d 705(6th Cir. 2012):

• Prior to filing, Global Technovations, Inc. (“GTI”), the debtor, purchased

Onkyo America Incorporated (“OAI”), a subsidiary of Onkyo Corporation (“Onkyo”) for $25 million, consisting of $13 million in cash and $12 million in three-year promissory notes.

• At the time of the filing, OAI was still owed $12 million and filed a proof of claim to recover the remainder of the purchase price.

• GTI responded by commencing an adversary proceeding against OAI claiming that the purchase was a fraudulent transfer under 11 U.S.C. § 544(b)(1) and Florida fraudulent transfer statutes and to disallow claims pursuant to 11 U.S.C. §502(d) was commenced.

29

The Rulings of the Appellate Courts • In the bankruptcy case, Judge Tucker held that (i) the fraudulent transfer

claims constituted “core” proceedings under 28 U.S.C. § 157(b)(2)(H) and (ii) the Section 502(d) claim-disallowance count was core under 28 U.S.C. §157(b)(2)(B) and, thus, the bankruptcy court had authority to rule on the matter.

• The bankruptcy court found that the purchase of the business by the debtor constituted a fraudulent, voidable transfer and that at the time of the transfer OAI was worth $6.9 million, not $25 million.

• Accordingly, the debtor’s obligation to pay OAI the remainder due for the sale was voided, and Onkyo was ordered to pay the debtor $6.1 million, being the difference between the $13 million that the debtor had previously paid and the $6.9 million the bankruptcy court had determined to be the value of OAI.

• The ruling of the bankruptcy court was affirmed by the district court.

30

The Rulings of the Appellate Courts • Both of the lower court decisions were decided before Stern v. Marshall. • After the Supreme Court issued its decision in Stern, the Sixth Circuit Court

of Appeals asked the parties to file supplemental briefs to address whether, in light of Stern, the bankruptcy court was constitutionally permitted to enter a final judgment ordering the defendants to pay approximately $6.1 million plus interest and costs.

• In addition, because the case now presented a request regarding the constitutionality of a federal statute – that being whether the bankruptcy court had authority to “hear and decide” a debtor’s fraudulent conveyance claim under 28 U.S.C. § 157(b)(2)(H) is constitutional – the Court of Appeals advised the Solicitor General and invited the United States to file an amicus brief.

31

The Rulings of the Appellate Courts • The government filed an amicus brief and argued that: (i) the Court did not need to reach the Article III issue because the parties had waived any constitutional objection to the bankruptcy court adjudication of the matter by failing to object to the bankruptcy court adjudicating the matter at the outset and by failing to raise any constitutional objection at any point during the subsequent appeal proceedings, despite having had repeated opportunities to do so ; and (ii) in reliance of Katchen v. Landy and Langenkamp v. Culp ,a bankruptcy judge may properly enter final judgment on a fraudulent conveyance claims against a creditor, where ruling on the creditor’s claim against the estate necessarily requires the resolution of the fraudulent conveyance claim, the adjudication of the claim fell within the “public rights” exception as an action integral to the debtor- creditor relations, and the creditor had consented to having the bankruptcy court adjudicate those claims necessarily integral to the resolution of the claim.

32

The Rulings of the Appellate Courts • The appellant filed a supplemental letter brief addressing the impact of

Stern v. Marshall and contended that all of the issues on appeal relating to the methodology used by the bankruptcy court in assessing value were issues of law subject to de novo review and, thus, from a practical perspective, would not be impacted by Stern.

• To the extent, however, that the district court on appeal below reviewed the bankruptcy court’s findings on a “clearly erroneous” standard, the appellant contended that such standard did not comport with Stern and that the judgment should be reversed and remanded to the district court for de novo review.

• Finally, the appellant argued that the claims at issue in the adversary proceeding – fraudulent conveyance claims – were “private rights” of action meant to “augment the estate.”

33

The Rulings of the Appellate Courts • The appellee also filed a supplemental brief and argued: (i) Stern was decided on a narrow basis; (ii) Stern does not affect the bankruptcy court’s authority to enter judgments on claims that are resolved in connection with a creditors’ proof of claim; (iii) the fraudulent conveyance transfer claim was necessarily resolved in connection with the proof of claim filed by the appellant; (iv) the appellant had “consented” to the bankruptcy court’s authority to issue a final ruling by (a) filing the proof of claim, (b) admitting in their answer that the bankruptcy court had jurisdiction and it was a core proceedings, (c) consenting and agreeing that it was a core matter in the final pre-trial statement, (d) not contesting jurisdiction and venue in the second revised pretrial statement, (e) after losing the case, appellant did not raise an objection in their pleadings on appeal, thereby waiving this argument, and (f) the appellant conceded that the bankruptcy court had subject matter jurisdiction over the adversary proceeding (even though Stern is not about jurisdiction, but rather the authority to the court “to hear and determine.”).

34

The Rulings of the Appellate Courts Onkyo argued on appeal: (i) GTI failed to establish the value it paid and the value it received in the OAI transaction; (ii) GTI failed to prove the value of its promissory notes; and (iii) GTI failed to prove the value of all the economic benefits that it received from the transaction. At the heart of these issues were concerns that the bankruptcy court had allegedly used “hindsight” (i.e., improper methodology) to assess value, had only relied on portions of expert testimony, and had failed to consider properly value the assets received (including alleged “indirect benefits”) and that such issues were issues of law requiring de novo review.

35

The Rulings of the Appellate Courts After dismissing all of the arguments raised by Onkyo and affirming the lower court decisions, the Court addressed and determined that it had authority to require Onkyo to pay GTI $6.1 million because: (i) Unlike in Granfinanciera, Onkyo had filed a proof of claim, thereby voluntarily bringing itself into the bankruptcy court; and (ii) The debtor’s defense to the proof of claim was the fraudulent transfer and, according to the court, it was not possible to rule on the proof of claim without first resolving the fraudulent transfer.

36

The Rulings of the Appellate Courts The Court then indicated that while the bankruptcy court did not know at the outset of the case whether Onkyo’s claim would be disallowed in its entirety, the bankruptcy court had jurisdiction under Stern to make the additional finding that Onkyo was a “good faith transferee” and a “good faith obligee” for purposes of receiving a credit (i.e., a reduction in liability) in the course of resolving the debtor’s fraudulent transfer defense. In reliance of Katchen, the court also held that the bankruptcy court had jurisdiction under Stern to enter judgment and award affirmative relief – “it was a simple matter of subtraction” once the court had determined that the sale was fraudulent and Onkyo was a good faith transferee.

37

The Rulings of the Appellate Courts Waldman v. Stone, __ F.3d __, 2012 WL 5275241 (6th Cir. 2012) • Ron Stone, the chapter 11 debtor, brought an adversary

proceeding against Randall Waldman, his principal creditor, asserting fraud and other claims.

• The bankruptcy court found that Waldman had obtained nearly all of Stone’s business assets by means of fraud.

• The court, for relief, discharged the debts that Stone owed to Waldman and further awarded Stone more than $3 million in compensatory and punitive damages.

• The decision of the bankruptcy court was affirmed by the district court. The appeal to the Sixth Circuit followed.

38


• Waldman challenged the bankruptcy court’s judgment, including that the bankruptcy court lacked constitutional authority to have awarded damages to Stone on three grounds:

(i) Stone’s state-law fraud claims are beyond the jurisdiction of any federal court; (ii) The judgment was beyond the statutory authority of the bankruptcy court in particular; and (iii) The judgment was beyond the bankruptcy court’s power as limited by Article III of the Constitution.

39


• The Court first dismissed Waldman’s contention that Stone’s claims did not “arise under” federal law because he “overlook[ed] that a debtor’s state-law claim, even for affirmative relief, “may be adjudicated in federal court on the basis of its relationship to the petition for reorganization.””

• The Court next found that Stone’s claims, even though based on state law, were “related to” the bankruptcy because the outcome of such claims could conceivably have an effect on the estate being administered in bankruptcy – here being, a disallowance of claims sought to be enforced and additional assets for Stone’s other creditors.

40


• The Court then dismissed Waldman’s contention that because the claims were not “core proceedings” the bankruptcy court did not have authority to issue final rulings because, in reliance of Stern and 28 U.S.C. § 157, Waldman had forfeited this objection by having expressly stated that the case was core in his answer to the complaint.

41

The Rulings of the Appellate Courts • The Court next addressed the argument by Waldman that the

bankruptcy court lacked constitutional authority to enter judgment on Stone’s claims.

• Stone and the government (as an amicus curiae) contended that Waldman had forfeited this objection by failing to raise it below.

• The government also contended that “neither the Executive nor the Legislature had encroached upon the Judiciary “by the bankruptcy court acting because “Waldman’s object [was] based upon a waivable ‘personal right,’ rather than a non-waivable structural principle.”

• The Court did not agree and stated that the government’s argument “takes too narrow a view of the interests preserved by Article III.” 42


• In reliance of Stern and Schor, 478 U.S. at 850, the Court further noted that “Waldman’s objection . . . Implicate[d] not only his personal rights, but also the structural principle advanced by Article III. And that principle is not Waldman’s to waive.” (Emphasis added)

• The Court, ultimately, concluded that the bankruptcy court

had authority to discharge of Stone’s debt as part of the adjudication of his objection to Waldman’s claims but the bankruptcy court lacked authority to award him damages.

43


The basis of the ruling by the Sixth Circuit: (i) The adjudication of “private rights,” described as the liability of one individual to another under the law as defined is part of the judicial power reserved to Article III courts under the Constitution and, bankruptcy courts cannot enter final judgments on such claims unless they fall within the “public rights” exception to Article III. (ii) A “public right” derives from a federal regulatory scheme or in which resolution of the claim by an expert governmental agency is essential to a limited regulatory objective within the agency’s authority.

44


(iii) The “restructuring of the debtor-creditor relations” (a bankruptcy power) is separate and distinct from the adjudication of “state-created rights” (an Article III judicial power). (iv) The “public rights” doctrine does not extend to what are “quintessentially suits at common law that more nearly resemble state-law contract claims . . . To augment the bankruptcy estate rather than they do creditors’ hierarchically orders claims to a pro rata share of the bankruptcy res.”

45

The Rulings of the Appellate Courts (v) As relates to the disallowance of Stone’s claims against Waldman – i.e., the discharge of a judgment, judgment liens on his property and a mortgage – obtained by fraud, such claims arose under the bankruptcy court because: (a) This claim does not involve the granting of affirmative relief, but rather preventing Waldman from taking action to collect on his claims obtained through fraud against Stone. (b) Granting such relief was integral to addressing the claim, something that was authorized by Stern. (c) Waldman had waived his right to trial by jury and resolution of debtor-creditor relations is an equity function of the bankruptcy court.

46

The Rulings of the Appellate Courts (d) While Waldman had not filed a proof of claim, the bankruptcy court still had authority to adjudicate Stone’s objection because: (i) he was the principal creditor and “surely would have filed a claim if Stone had not beat him to the courthouse,” (ii) Waldman appeared in the bankruptcy proceeding, counterclaimed and sought relief from the automatic stay to enforce his security interest and take possession of Stone’s property, and (iii) as a secured creditor, Waldman was not required to file a proof of claim to preserve his right to recover from the estate.

47

The Rulings of the Appellate Courts The Court, thus, concluded that: “We do not read the Court’s precedents to require the bankruptcy courts to abandon this power (i.e., to enter final judgment on Stone’s disallowance claims), which they had exercised for more than two centuries.” However, with respect to Stone’s affirmative claims seeking money damages from fraud, those claims, like Vickie’s counterclaim in Stern, “arose exclusively under state law and existed without regard to any bankruptcy proceeding.” The damage claims were “not part of Stone’s effort to restructure” but only sought money damages to augment the bankruptcy estate.”

48

The Rulings of the Appellate Courts While Stone argued that the affirmative damage claims turned on the same fraudulent conduct as his disallowance claim, the Court stated that “’some overlap’ between the claims is not enough.” “. . . [F]or a bankruptcy court to enter final judgment as to claims that seek an award of money damages to the estate, there must have been, at the outset of the claims-disallowance process, ‘reason to believe that the process of adjudicating[the] proof of claim would necessarily resolve’ the damages claim.” In this case, the Court found that “Stone’s affirmative claims required him to prove facts beyond those necessary to his disallowance claims.”

49

The Rulings of the Appellate Courts After concluding that the bankruptcy court’s judgment of damages was entered in violation of Article III, the Court next considered how to address the violation. The Court recognized that the practical remedy (i.e., to have the bankruptcy court make recommendations to the district court to review de novo) , if the claims asserted by Stone are “core,” is not expressly addressed in the statute and suggested that the bankruptcy court might not have power to even make recommendations in core proceedings as to which Article III bars the bankruptcy court from entering final judgments (in other words, in the core unconstitutional area).

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The Rulings of the Appellate Courts The Court, however, held that Stone’s affirmative claims for damages were not “core,” but rather “ordinary state-law claims for fraud,” for which the bankruptcy court could make recommendations under 28 U.S.C. § 157(c)(1). While both parties contended that the claims were “core,” the Court indicated that Waldman could not now challenge the Court’s finding that the claims were only “related to” as the Court treated such contention as having been waived. The case was thus remanded to the bankruptcy court to “recast its judgment as to Stone’s affirmative claims” as recommendations. 51

The Rulings of the Appellate Courts Executive Benefits Insurance Agency, Inc. v. Arkison (In re Bellingham Insurance Agency, Inc.), 661 F.3d 476 (9th Cir. 2011): • This case arose in the context of a chapter 7 case in

which a trustee sought to avoid the transfer of a debtor’s assets by its principals to a new entity for no consideration after an adverse arbitrate award as a fraudulent transfer.

• The bankruptcy court granted summary judgment for the trustee and the district court affirmed its decision.

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• The case was appealed to the ninth circuit Court of Appeals and, while the case was pending, Stern v. Marshall was decided by the Supreme Court.

• The Ninth Circuit, thereupon, requested the parties to brief whether the bankruptcy court lacks authority to issue a final, binding judgment in an adversary proceeding seeking to avoid a fraudulent transfer and, thus, may only “hear” the matter and issue a report and recommendation of proposed findings to the district court.

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The Rulings of the Appellate Courts • Twelve amicus briefs have been submitted to the court,

including one by the Department of Justice (“DOJ”) in which the DOJ contends that 28 U.S.C. § 157(b)(2)(H) is unconstitutional as applied to fraudulent transfer actions against non-creditor defendants who have not consented to a final adjudication by the bankruptcy court.

• The DOJ’s amicus brief is premised on a careful reading of Stern and Granfinanciera (that was cited by the Supreme Court, with approval, in Stern).

• See Goldblatt, Craig and Spinelli, Danielle, Bellingham: No Reasonable Argument for “Narrow” Reading of Stern,” ABI Journal of Bankruptcy Law (April 2012).

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Implications from the Appellate Rulings and Limitations on the

What a Bankruptcy Court Can Do

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Does a bankruptcy court have authority to issue a final ruling in:

• A fraudulent conveyance where (i) a proof of claim is filed or (ii) no proof of claim is filed?

• A preference where (i) a proof of claim is filed or (ii) no proof of claim is filed?

• Approval of a settlement under Bankruptcy Rule 9019 if the underlying claims subject to settlement require an Article III court?

• The grant of third party injunctions and/or releases under a plan of reorganization?

• A dischargeability action in which the entry of a money judgment may be requested?

• A sale of property in which a third party who has not filed a proof of claim has an interest?

• A request for equitable subordination of a claim in which the claimant has not filed a proof of claim?

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Statutory Authority

28 U.S.C. § 1334 28 U.S.C. § 157

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28 U.S.C. §§ 1334 (c)(1) & (2)

(c)(1) Except with respect to a case under chapter 15 of title 11, nothing in this section prevents a district court in the interest of justice, or in the interest of comity with State law, from abstaining from hearing a particular proceeding arising under title 11 or arising in or related to a case under title 11.

(c)(2) Upon timely motion of a party in a proceeding based on a State law

claim or State law cause of action, related to a case under title 11 but not arising under title 11 or arising in a case under title 11, with respect to which an action could not have been commenced in a court of the United States absent jurisdiction under this section, the district court shall abstain from hearing such a proceeding if an action is commenced, and can be timely adjudicated, in a State forum of appropriate jurisdiction.

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28 U.S.C. §§ 1334 (a) & (b)

(a) Except as provided in subsection (b) of this section, the district courts

shall have original and exclusive jurisdiction of all cases under title 11. (b) Except as provided in subsection (e)(2), and notwithstanding any Act of

Congress that confers exclusive jurisdiction on a court or courts other than the district courts, the district courts shall have original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11.

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28 U.S.C. §§ 1334 (c)(1) & (2) • (c)(1) Except with respect to a case under chapter 15 of title 11, nothing in

this section prevents a district court in the interest of justice, or in the interest of comity with State law, from abstaining from hearing a particular proceeding arising under title 11 or arising in or related to a case under title 11.

• (c)(2) Upon timely motion of a party in a proceeding based on a State law claim or State law cause of action, related to a case under title 11 but not arising under title 11 or arising in a case under title 11, with respect to which an action could not have been commenced in a court of the United States absent jurisdiction under this section, the district court shall abstain from hearing such a proceeding if an action is commenced, and can be timely adjudicated, in a State forum of appropriate jurisdiction.

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28 U.S.C. § 157(b)

(b)(1) Bankruptcy judges may hear and determine all cases under title 11 and all core proceedings arising under title 11, or arising in a case under title 11, referred under subsection (a) of this section, and may enter appropriate orders and judgments, subject to review under section 158 of this title. (Emphasis added)

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28 U.S.C. § 157(b)(2) (2) Core proceedings include, but are not limited to the following:

(A) matters concerning the administration of the estate; (B) allowance or disallowance of claims against the estate or

exemptions from property of the estate, and estimation of claims and interests for the purposes of confirming a plan under chapter 11, 12 or 13 of title 11 but not the liquidation of estimation of contingent or unliquidated personal injury tort or wrongful death claims against the estate for purposes of distribution in a case under title 11;

(C) counterclaims by the estate against persons filing claims against the estate;

(D) orders in respect to obtaining credit; (E) orders to turn over property of the estate; (F) proceedings to determine avoid, or recover preferences; (G) motions to terminate, annul, or modify the automatic stay;

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28 U.S.C. § 157(b)(2)

(H) proceedings to determine, avoid or recover fraudulent conveyances;

(I) determinations as to the dischargeability of particular debts; (J) objections to discharges; (K) determinations of the validity, extent, or priority of liens; (L) confirmations of plans; (M) orders approving the use or lease of property, including the use

of cash collateral; (N) orders approving the sale of property other than property

resulting from claims brought by the estate against persons who have not filed claims against the estate;

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28 U.S.C. § 157(b)(2)

(O) other proceedings affecting the liquidation of the assets of the estate or adjustment of the debtor-creditor or the equity security holder relationship, except personal injury tort or wrongful death claims; and

(P) recognition of foreign proceedings and other matters under chapter 15 of title 11.

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28 U.S.C. § 157(b)(3)

The bankruptcy judge shall determine, on the judge’s own motion or on timely motion of a party, whether a proceeding is a core proceeding under this subsection or is a proceeding that is otherwise related to a case under title 11. A determination that a proceeding is not a core proceeding shall not be made solely on the basis that its resolution may by affected by State law.

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28 U.S.C. §§ 157(c)(1) & (2)

(1) A bankruptcy judge may hear a proceeding that is not a core proceeding but that is otherwise related to a case under title 11. In such proceeding, the bankruptcy judge shall submit proposed findings of fact and conclusions of law to the district court, and any final order or judgment shall be entered by the district judge after considering the bankruptcy judge’s proposed findings and conclusions and after reviewing de novo those matters to which any party has timely and specifically objected.

(2) Notwithstanding the provisions of paragraph (1) of this subsection, the district court, with the consent of all parties to the proceeding, may refer a proceeding related to a case under title 11 to a bankruptcy judge to hear and determine and to enter appropriate orders and judgments, subject to review under section 158 of this title.

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28 U.S.C. §§ 157(d) & (e)

(d) The district court may withdraw, in whole or in part, any case or proceeding referred under this section, on its own motion or on timely motion of any party, for cause shown. The district court shall, on timely motion of a party, so withdraw a proceeding if the court determines that resolution of the proceeding requires consideration of both title 11 and other laws of the United States regulating organizations or activities affecting interstate commerce.

(e) If the right to jury trial applies in a proceeding that may be heard under

this section by a bankruptcy judge, the bankruptcy judge may conduct the jury trial if specially designated to exercise such jurisdiction by the district court and with the express consent of all the parties.

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STERN v. MARSHALL MATRIX

Plenary Summary

Legal Equitable

Private

Public

Augmentation Claim not necessarily resolved by the claims allowance process

Administration of the Estate Claim will necessarily be resolved by the claims allowance process

Stranger

Willing Participant

7th Amendment Equitable

Non-Core, Related to In Personam

Core In Rem

No Express Consent Article III Core-Unconstitutional

Express Consent (?) (case law does not yet fully support) Article I Arising In/Arising Under

Hear Hear and Determine (authority to act)

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i consent [to the bankruptcy court hearing] – not so...

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