Every civil litigator should be familiar with bankruptcy courts’ jurisdiction and authority to enter final judgments, because virtually any civil case could find its way to a bankruptcy court. Because of bankruptcy courts’ broad jurisdiction, a wide variety of issues may be litigated in bankruptcy court. These could include evictions,1 foreclosures,2 the validity3 of and right to payment from trusts, consumer protection law claims,4 defamation,5 and domestic support arrears.6 As a result, nonbankruptcy lawyers can, and often do, find themselves in bankruptcy court.
In 2011, in Stern v. Marshall,7 the U.S. Supreme Court cast doubt on bankruptcy courts’ authority to enter final judgments on many claims.8 This created uncertainty about when a bankruptcy court could enter a final judgment on state law claims. The Court has recently, in two cases, provided a bit more clarity about how bankruptcy courts may handle these claims and whether parties may consent to having a bankruptcy court enter a final judgment.
This article provides a brief primer on bankruptcy court jurisdiction, an overview of what happens when a party files bankruptcy, and a summary of what nonbankruptcy lawyers should know about consenting to a final judgment by the bankruptcy court. Whether a party elects to litigate and consent to a final judgment in bankruptcy court is a tactical decision that could affect the cost, duration, and possibly outcome of the case.
Stern and Bankruptcy Court Jurisdiction
Congress enacted the current statutes in response to the U.S. Supreme Court’s 1982 decision in Northern Pipeline Construction Co. v. Marathon Pipe Line Co. Before that case, in 1978, Congress enacted a new bankruptcy code that gave bankruptcy judges, whose authority derives from article I of the U.S. Constitution and who lack lifetime tenure unlike like article III judges, broad powers to decide disputes.9 The Marathon court struck down the statutory scheme, because it impermissibly gave judges without lifetime tenure the power to decide disputes that were outside the “restructuring of debtor-creditor relations, which [was] at the core of the federal bankruptcy power.”10
Nicholas Hahn, U.W. 2013 magna cum laude, Order of the Coif, is an associate at Steinhilber, Swanson, Mares, Marone, & McDermott, Oshkosh, where he focuses on bankruptcy and insolvency. From 2013-15, he was a judicial law clerk for the Hon. Robert J. Faris, Bankruptcy Court, District of Hawaii, to whom he is indebted for his mentorship. He is admitted to practice in the state courts of Hawaii and Wisconsin, as well as the Eastern and Western District Courts in Wisconsin.
In 1984, Congress created the new scheme11 to try to avoid the Court’s concerns,by giving bankruptcy judges the power to decide only “core”12 proceedings, a reference to the language in Marathon. Almost 30 years later, the Stern decision made the current scheme less clear by holding that bankruptcy judges cannot constitutionally decide some proceedings the statute labels core.
Statutory Framework. District courts have original and exclusive jurisdiction over bankruptcy cases.13 These comprise proceedings that “aris[e] under [the Bankruptcy Code], or aris[e] in or [are] related to a case under [the Bankruptcy Code].”14 Each of these categories refers to a specific type of proceeding. So a proceeding that “arises under” the Code is one that depends on a “substantive right created by bankruptcy law.”15 A proceeding that “arises in” a bankruptcy case is one that is not based on the bankruptcy code, but would not exist but for the bankruptcy.16 Finally, a proceeding is related to the bankruptcy case if it would have any significant connection to the case or if it might have any conceivable effect on the case.17
In turn, district courts may refer “any or all” bankruptcy cases and proceedings to bankruptcy judges, although these judges do not have life tenure.18 In almost all districts, all bankruptcy matters are automatically referred to bankruptcy courts.19
Bankruptcy courts, however, do not have the same authority as the district court. Bankruptcy judges may “hear and determine” bankruptcy cases and core proceedings.20 But they may only “hear” – not determine – a noncore proceeding that is related to a bankruptcy case.21 In plain terms, this means that bankruptcy courts may hold a trial, or otherwise resolve matters, and enter a final judgment in core proceedings; in noncore proceedings, they can only submit recommendations for resolution to the district court.22
This invites the question: what are cases and proceedings? The bankruptcy case is “the umbrella under which” proceedings arise.23 Thus, a proceeding can be anything from a mundane motion to obtain credit or sell property to more complex litigation similar to civil suits. The bankruptcy court decides most proceedings in the main bankruptcy case. However, for some matters, parties may initiate adversary proceedings,24 which is the bankruptcy analogue to traditional civil suits.
A concrete illustration might be helpful. Imagine that a debtor files bankruptcy. A creditor or the trustee files an adversary proceeding. The bankruptcy judge generally has the authority to enter orders and final judgments in the main bankruptcy case. These might include a bank’s motion for relief from the automatic stay to foreclose on the debtor’s home or the trustee’s motion to sell the debtor’s nonexempt real property. But if a proceeding concerns a noncore claim, then the judge can only make a recommendation to the district court. This recommendation could concern a motion to dismiss, a motion for summary judgment, or even a recommendation to enter a final judgment after a full trial.
Failing to object to entry of a final judgment in the bankruptcy court can lead to a party being deemed to have consented.
In 2011, however, the Supreme Court challenged this clear statutory scheme in Stern v. Marshall.
Stern v. Marshall. In Stern, Vickie Marshall (better known as Anna Nicole Smith) filed a Chapter 11 bankruptcy in California after the death of her husband, a billionaire. Before her husband died, Vickie sued her husband’s son, Pierce Marshall, in Texas state court for tortious interference with a gift from her husband’s estate.
After Vickie filed bankruptcy, Pierce filed a claim against the bankruptcy estate for defamation, alleging that Vickie defamed him in the Texas litigation by telling the press he fraudulently induced his father to exclude Vickie from his trust. In response, she filed a counterclaim, alleging that Pierce interfered with a gift from her husband. The bankruptcy court granted Vickie summary judgment, over Pierce’s objection that the bankruptcy court did not have jurisdiction to enter a final judgment, despite 28 U.S.C. § 157.25
The issue before the Supreme Court was whether the bankruptcy court had statutory and constitutional authority to enter a final judgment on the estate’s state-law counterclaim. It held that under the statute, the bankruptcy court had the statutory authority to enter a final judgment on Vickie’s counterclaim26 but lacked constitutional authority to do so.27 The majority reasoned that a bankruptcy debtor’s state-law claim does not fall into the so-called public-rights exception to the Constitution’s requirement that judges appointed with lifetime tenure under article III exercise the judicial power.28 In the majority’s view, allowing a judge without life tenure to enter a final judgment on a common-law claim would violate the separation of powers.29
What Is a “Stern Claim”? Since Stern, courts have found that bankruptcy judges cannot constitutionally enter a final judgment in many instances when the statute says they can.30 Consequently, there is a category of proceedings labeled core that bankruptcy courts cannot constitutionally decide.31 These are called “Stern claims” or “gap claims,” in reference to the “gap” between the statutory and constitutional authority to enter a final judgment.
At a minimum, lawyers should be aware that proceedings in the following statutory categories might be Stern claims: 1) counterclaims by the estate against claimants against the bankruptcy estate,32 2) proceedings to turn over property of the estate,33 3) proceedings to avoid fraudulent transfers,34 and 4) proceedings in the catch-all category.35
A good rule of thumb is that if your client is not in bankruptcy, but is facing an adverse judgment in bankruptcy court on a claim to bring money or property into the estate or on a claim based on nonbankruptcy law, you should investigate whether there is a Stern issue.
Determining whether there is a Stern issue is not necessarily a straightforward task, because the Supreme Court has not provided a bright-line rule. For instance, preference and fraudulent-transfer claims are codified in the Bankruptcy Code, but they most likely are Stern claims.36 The most common Stern claims include fraudulent-transfer actions,37 pre-petition claims the bankruptcy estate initiates in or removes to bankruptcy court,38 and the bankruptcy estate’s counterclaims against nondebtors that are not necessary to resolve a claim against the estate.39
In addition, some courts have read Stern as requiring a two-part test.40 First, the court determines whether the proceeding is a statutorily core proceeding. Then it determines if either of two conditions is true: 1) the proceeding “‘stems from the bankruptcy itself,’” or 2) the proceeding “‘would necessarily be resolved in the claims-allowance process.’”41 If neither condition is met, there is a Stern claim, and the bankruptcy court cannot constitutionally enter a final judgment.42 Although courts in both the Eastern and Western Districts of Wisconsin have relied on this test,43 it remains to be seen whether appellate courts will adopt it.
Here is an example. Suppose a bankruptcy debtor operates an office building. He files an action in bankruptcy court against a tenant to evict the tenant and to collect unpaid rent. Those would be Stern claims. The court would have jurisdiction to hear the claims, since they are “related to” the bankruptcy case. But neither claim either “stems from the bankruptcy itself” or “would necessarily be resolved in the claims allowance process.” So the bankruptcy court could not constitutionally decide them. However, suppose the tenant files a claim against the debtor for breaching his obligations to repair the tenant’s office. The claim for unpaid rent would not be a Stern claim if it were necessary to decide the tenant’s breach-of-contract claim.
More Clarity after Executive Benefits and Wellness International Network. Two bankruptcy cases decided by the Supreme Court since Stern provide clarity on how lawyers and judges should respond to Stern claims.
In Executive Benefits Insurance Agency v. Arkison,44 a company’s bankruptcy trustee sued another company to recover a fraudulent transfer both companies’ principal had made. The bankruptcy court ruled in the trustee’s favor, but on appeal, the district court treated the bankruptcy court’s findings of facts and conclusions as a recommendation and reviewed it de novo. On appeal, the Supreme Court avoided determining if the fraudulent-transfer action was a Stern claim. Instead, it held that if a bankruptcy court believes there might be a Stern issue, it should enter proposed findings of fact and conclusions of law for the district court to review de novo.45
In Wellness International Network Ltd. v. Sharif, issued in 2015, the bankruptcy trustee sued for a declaratory judgment, alleging that $5 million in assets of an alleged trust the debtor supposedly administered for his sister’s benefit was property of the bankruptcy estate and available to pay creditors. The debtor did not object to the bankruptcy court’s jurisdiction until after the court entered a default judgment against him and he appealed to the Seventh Circuit. On appeal, the Supreme Court majority held that if the debtor consented – explicitly or implicitly – to the bankruptcy court entering a final judgment, then the bankruptcy court may constitutionally do so.46 Consequently, it remanded for a determination on that issue.
Reading the two cases together, two things are now clear: 1) if there is a Stern claim or if the bankruptcy judge is unsure, he or she may submit a recommendation to the district court judge to enter a final judgment; and 2) parties may consent to the bankruptcy court entering a final judgment.
What to Know When a Litigant Files Bankruptcy
If the Plaintiff Files Bankruptcy. When a debtor files a petition for bankruptcy, all of the debtor’s legal and equitable interests in property, subject to a few narrow exceptions, become property of the bankruptcy estate.47 This includes the debtor’s pre-petition causes of action, whether or not the debtor sued on them.48 In a Chapter 7 case, the bankruptcy trustee has the right to determine how and if he or she litigates a cause of action for the benefit of creditors,49 unless there is an exemption available to protect the cause of action from the trustee.50 In cases brought under the other chapters, the debtor may generally litigate the action.51
The trustee or debtor may seek to enforce the claim in any forum in which jurisdiction exists.52 If a case is already pending in state court, the case may remain there. But often the trustee or debtor would prefer to litigate in bankruptcy court.
There are good reasons for the latter decision. For instance, bankruptcy judges may have more expertise on particular subjects, such as commercial law and financial transactions. The bankruptcy court may also be a more efficient forum. And the bankruptcy process allows nearly all litigation to be centralized. Rather than litigate claims in different courts and before different judges, bankruptcy allows all the claims by and against the debtor to be decided in one place regardless of the other parties’ location. Thus, in bankruptcy court, one judge who is familiar with the debtor’s situation can handle all the related proceedings.
In situations in which the bankruptcy estate has initiated a proceeding on a pre-bankruptcy claim against a nondebtor, there will most likely be a Stern claim under cases like Marathon and Stern. The major exception to this is if the debtor’s claim is also a counterclaim necessary to resolve a claim against the estate.53 Counsel should assess whether he or she wants to consent to a final judgment in bankruptcy court or take some other action.
If the Defendant Files. If the defendant files bankruptcy, any pre-petition (before bankruptcy) claims against that party become claims against the estate. In that situation, the bankruptcy court may, in general, constitutionally decide the claim,54 unless the claim is in one of the excluded categories under 28 U.S.C. § 157 or possibly some admiralty claims.55
Nonbankruptcy Court Options. Litigants’ options are not confined to litigating an issue in bankruptcy court. Other options might be appropriate. For instance, a party may file a motion with the district court to withdraw its reference to the bankruptcy court.56 In my experience, this is rarely an effective tactic, unless the proceeding was already pending in district court or there is a related matter pending there.
District court judges generally have significant caseloads and might not want to increase those burdens. In addition, district court judges frequently prefer to leave bankruptcy-related matters to bankruptcy judges because of the latter’s expertise in those matters, unless the decision is presented to them due to an appeal. Similarly, if a proceeding had been pending in state court, or if a state court is better suited to the matter, counsel may file a motion for relief from the automatic stay57 to proceed in state court or to request the bankruptcy court to abstain from hearing and deciding the case.58
Once lawyers have determined whether there is a potential Stern issue, they should state relatively quickly whether they consent to entry of a final judgment by the bankruptcy judge. In adversary proceedings, lawyers should address this in the complaint and answer when they address the court’s jurisdiction.59 In other proceedings, they should address Stern issues as soon as possible.
Failing to object to entry of a final judgment in the bankruptcy court can lead to a party being deemed to have consented.60 As the Wellness majority stated, neither the Constitution nor the statute requires a litigant’s consent to be express.61 Even before Wellness, courts deemed objections waived if litigants “sandbagged” the court and other parties.62 However, as Justice Alito’s Wellness concurrence explained, the bankruptcy rules require that a party’s consent be express.63 In spite of this concurrence and the rules, if a party does not expressly state its position, the party risks forfeiting that right.
The primary consideration in determining whether to consent to a final judgment is the strength of one’s case. The reason for this is the difference in how the district court reviews the bankruptcy court’s decision. If a party does not consent to a final judgment, the bankruptcy court submits to the district court proposed findings of fact and conclusions of law, which the district court reviews de novo.64
On de novo review, the district court must independently review the facts and law. But the district court judge is not limited to what was presented at the bankruptcy court. It may take new evidence and arguments.65 For instance, the district court in the Stern litigation held an evidentiary hearing over several weeks.66 The district court should not “rubber-stamp” the bankruptcy court’s recommendation, but it can adopt it without another trial.67 Thus, for the loser at the bankruptcy court, not consenting affords a “second bite at the apple.” But, for the winner, not consenting potentially means a costly and unsuccessful second trial, depending on how the district court decides to review the evidence.
In contrast, if the parties consent to a final judgment, they have a right to appeal the judgment to the district court or the bankruptcy appellate panel.68 On appeal, the tribunal applies the traditional standards of appellate review: the clearly erroneous standard for factual issues and de novo for legal issues.69 As a result, the chance of reversal is smaller.
In sum, consenting to a final judgment at the bankruptcy court has two main benefits. First, if both parties consent, the winner does not have to potentially relitigate the case at the district court and incur more costs. And second, a final judgment at the bankruptcy court could give the parties an incentive to settle more quickly, because there is no possibility of relitigating the case at the district court.
Conversely, the cost of not consenting is potentially relitigating a substantial portion of the case or allowing the district court judge to draw different inferences from the evidence. Withholding consent could be a wise tactical move if the other side does not have the financial wherewithal or time for more drawn-out litigation.
Because almost any civil matter may be pulled into bankruptcy court, all litigators should be aware of bankruptcy jurisdiction and how to resolve Stern claims. Stern claims are those claims in a class of proceedings, in which bankruptcy judges are statutorily, but not constitutionally, authorized to enter final judgments. If a bankruptcy court is faced with a Stern claim, absent the parties’ consent, it may still resolve the case through a trial or dispositive pre-trial motions and send a recommendation to the district court.
1 Eugenio v. Continental Pac. LLC (In re Eugenio), No. HI-13-1459-KuJuKi, 2015 Bankr. LEXIS 377 (B.A.P. 9th Cir. 2015) (holding that a bankruptcy court had jurisdiction to hear an eviction action against the debtor).
2 See 1250 Oceanside Partners v. Maryl Grp. Inc. (In re 1250 Oceanside), No. 13-00353, Adv. Pro. No. 13-90049, 2013 Bankr. LEXIS 4122, 8-9 (Bankr. D. Haw. Oct. 1, 2013).
3 Wellness Int’l Network Ltd. v. Sharif, 135 S. Ct. 1932 (2015).
4 See Kekauoha-Alisa v. Ameriquest Mortg. Co. (In re Kekauoha-Alisa), 674 F.3d 1083 (9th Cir. 2012) (affirming bankruptcy court’s avoidance of foreclosure sale under a consumer protection law).
5 See Stern v. Marshall, 131 S. Ct. 2594 (2011).
6 See, e.g., In re Poffenbarger, 281 B.R. 379, 395 (Bankr. S.D. Ala. 2002) (holding that alimony arrears are property of bankruptcy estate).
7 131 S. Ct. 2594 (2011).
8 Id. at 2611.
9 28 U.S.C. § 1471 (1982).
10 NorthernPipeline Constr. Co. v. Marathon Pipeline Co., 458 U.S. 50, 71 (1982).
11 Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98-353, 98 Stat. 333.
12 28 U.S.C. § 157(b)(2).
13 28 U.S.C. § 1334(a).
14 28 U.S.C. § 1334(b).
15 New York Skyline Inc. v. Empire State Bldg. Tr. Co. (In re New York Skyline Inc.), 512 B.R. 159, 172 n. 94 (S.D.N.Y. 2014) (quoting Glinka v. Murad (In re Housecraft Indus. USA Inc.), 310 F.3d 64, 70 (2d Cir. 2002)).
16 Id. (quoting Wood v. Wood (In re Wood), 825 F.2d 90, 97 (5th Cir.1987)).
17 Id. (quoting Lead I JV, LP v. North Fork Bank, 401 B.R. 571, 581 (E.D.N.Y. 2009)); Pacor Inc. v. Higgins, 743 F.2d 984, 994 (3d Cir. 1984).
18 28 U.S.C. § 157(a).
19 See, e.g., Order of Reference of the U.S. District Court, Eastern District of Wisconsin, July 16, 1984.
20 28 U.S.C. § 157(b)(1).
21 28 U.S.C. § 157(c)(1).
23 1-3 Alan N. Resnick & Henry J. Sommer, Collier on Bankruptcy ¶ 3.02 (16th ed. 2015), Lexis Advance [hereinafter Collier on Bankruptcy].
24 Fed. R. Bankr. P. 7001.
25 Stern, 131 S. Ct. at 2601-02.
26 Id. at 2604.
27 Id. at 2608.
28 Id. at 2611.
29 Id. at 2609-10.
30 See generally Tyson A. Crist, Stern v. Marshall: Application of the Supreme Court’s Landmark Decision in the Lower Courts, 86 Am. Bankr. L. J. 627 (2012).
31 See generally 1-3 Collier on Bankruptcy ¶ 3.02, supra note 23.
32 28 U.S.C. § 157(b)(2)(C).
33 28 U.S.C. § 157(b)(2)(E).
34 28 U.S.C. § 157(b)(2)(H).
35 28 U.S.C. § 157(b)(2)(O).
36 1-3 Collier on Bankruptcy ¶ 3.02[b], supra note 23 (“In Marathon and in Stern v. Marshall, there is considerable language that has led numerous courts to conclude that avoidance actions, even though created by the Bankruptcy Code, cannot be heard and determined by a nontenured judge, at least when the defendant has not filed a proof of claim.”).
37 Executive Benefits Ins. Agency v. Arkison (In re Bellingham Ins. Agency), 702 F.3d 553, 561 (9th Cir. 2012).
38 Northern Pipeline Constr. Co. v. Marathon Pipeline Co., 458 U.S. 50, 87 (1982) (Brennan, J. plurality).
39 Stern, 131 S. Ct. at 2611.
40 Crist, supra note 30, at 636-37.
41 Id. (quoting Burns v. Dennis (In re Se. Materials Inc.), 467 B.R. 337, 348 (Bankr. M.D.N.C. 2012)).
42 Id. (quoting Steinle v. Fall River Vill. Communities LLC (In re CCI Funding I LLC), 2012 WL 3070093, at *10 (Bankr. D. Col. 2012)).
43 Rinaldi v. HSBC Bank(In re Rinaldi), 487 B.R. 516, 524 (Bankr. E.D. Wis. 2013); Schmid v. Bank of Am. (In re Schmid), 494 B.R. 737, 745 (Bankr. W.D. Wis. 2013) (citing Rinaldi, 487 B.R. at 524).
44 Executive Benefits Ins. Agency v. Arkison, 134 S. Ct. 2165 (2014).
46 Id. at 1944-45.
47 11 U.S.C. § 541(a), (b).
48 Biesek v. Soo Line R.R. Co., 440 F.3d 410, 413 (7th Cir. 2006) (holding that a debtor’s pre-petition Federal Employers’ Liability Act claim was property of the estate).
49 11 U.S.C. § 323; 11 U.S.C. § 704(a)(1) (“The trustee shall … collect and reduce to money the property of the estate for which such trustee serves … as is compatible with the best interests of the parties in interest.…”); 6-704 Collier on Bankruptcy ¶ 704.03, supra note 23.
50 Polis v. Getaways Inc. (In re Polis), 217 F.3d 899, 901-02 (7th Cir. 2000) (discussing the debtor’s right to exempt a Truth In Lending Act claim); see Wis. Stat. § 815.18(3)(i) (Wisconsin’s statute exempting some life insurance, personal injury, and wrongful death claims).
51 11 U.S.C. § 1303; 11 U.S.C. § 1107(a); 11 U.S.C. § 1203; Cable v. Ivy Tech State College, 200 F.3d 467, 472-74 (7th Cir. 1999) (discussing debtors’ power to sue on claims that are property of the estate in reorganization chapters).
52 Fed. R. Bankr. P. 6009.
53 Stern, 131 S. Ct. at 2594 (“The Bankruptcy Court below lacked the constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor’s proof of claim.”); seeDePaola v. Sleepy’s LLC (In re Prof’l Facilities Mgmt.), No. 14-31095-WRS, Adv. Pro. No. 15-3041-WRS, 2015 Bankr. LEXIS 3643 (Bankr. M.D. Ala. Oct. 27, 2015) (holding that defendant may consent to bankruptcy court jurisdiction by filing counterclaim against estate even if it has not filed a formal claim and it expressly states it has not consented).
54 11 U.S.C. § 157(b)(2)(B); Katchen v. Landy, 382 U.S. 323, 335 (1966); 1-3 Collier on Bankruptcy ¶ 3.02[a], supra note 23.
55 U.S. Const., art. III, § 2, cl. 1 (“The judicial Power shall extend … to all Cases of admiralty and maritime Jurisdiction.…”); Clinton Snow & Peter Ruggero, Exposing Secret Maritime Liens in Bankruptcy, Am. Bankr. Inst. J., Dec./Jan. 2011, at 52, 53.
56 28 U.S.C. § 157(d).
57 11 U.S.C. § 362(d).
58 28 U.S.C. § 1334(c)(1).
59 Fed. R. Bankr. P. 7008(a); Fed. R. Civ. P. 8(a)(1); Fed. R. Bankr. P. 7012(b) (“If the response is that the proceeding is non-core, it shall include a statement that the party does or does not consent to entry of final orders or judgment by the bankruptcy judge.”).
60 Wellness Int’l Network, 135 S. Ct. at 1947-48; 1-3 Collier on Bankruptcy ¶ 3.02[b], supra note 23.
61 Wellness Int’l Network, 135 S. Ct. at 1947-48.
62 Rice v. Nova Biomedical Corp., 38 F.3d 909, 915 (7th Cir. 1994).
63 Wellness Int’l Network, 135 S. Ct at 1949 (Alito, J. concurring).
64 28 U.S.C. § 157(c)(1).
65 Id.; Fed. R. Bankr. P. 9033(d).
66 Marshall v. Marshall (In re Marshall), 275 B.R. 7 (C.D. Cal. 2002).
67 Moody v. Amoco Oil Co., 734 F.2d 1200, 1209-10 (7th Cir. 1984).
68 See 28 U.S.C. § 158.
69 Fed. R. Bankr. P. 8013.