By: Ramona Ortega
On June 23, 2011, the Supreme Court ruled 5-4, in Stern v. Marshall that Bankruptcy courts no longer have authority to make final judgments on state law counterclaims, even where the claims are “core proceedings.” The opinion by Chief Justice Roberts found that under Article III of the Constitution, a bankruptcy court does not have constitutional authority to decide on a common law cause of action even if the court has statutory authority under the bankruptcy code. The holding has stirred up a wave of controversy and speculation about the long term impact on bankruptcy courts and the practical implications for fraudulent transfer claims and other key bankruptcy proceedings.
The high courts ruling marks the end of a long drawn out saga involving Vickie Lynn Marshall (a/k/a Anna Nicole Smith) and her late husband, oil tycoon J. Howard Marshall. The proceedings commenced in 1995 in a Texas probate court just before the death of Marshall. Smith accused Pierce of fraudulently inducing Marshall to exclude her from the will. Subsequently, while litigation was still pending in Texas, Smith filed bankruptcy in a California court prompting Peirce to file a proof of claim for defamation. Smith later filed a $400 million counterclaim against Pierce for tortious interference with a gift expected from her late husband. The separate courts came to disparate rulings-the Texas court found for Pierce and the bankruptcy court found for Smith- leading to the 9th Circuit finding that the bankruptcy court lacked authority to enter a final judgment on Smith’s counterclaim.
On appeal to the Supreme Court Pierce argued that Smith’s counterclaim was not a “core” proceeding under the bankruptcy code and that the court lacked jurisdiction to enter a final judgment. Under 28 U.S.C. § 157 of the Code, bankruptcy proceedings are categorized as “core” or “non-core.” Specifically, § 157(b)(2)(c) lists 16 types of core proceedings, including counterclaims. Generally, bankruptcy courts are limited to making final judgments on core proceedings only.
Ultimately the Supreme Court found that Smith’s counterclaim fell within the definition of a “core proceeding” under the plain text of the code but went on to rule that Article III of the Constitution rendered the statutory provision unconstitutional and held that the Bankruptcy court did not have the authority to enter a final order on a state law counter-claim, even if it was “core” under the code. The court reasoned that the separation of powers would be defeated by allowing Congress to grant “judicial power on entities outside Article III.”
There is no doubt that Stern v. Marshall is an historic marker in bankruptcy law but the extent of its impact is still uncertain. What seems to be clear is that the decision casts a shadow of uncertainty on the fate of fraudulent transfers and preference avoidance claims in bankruptcy courts. A recent decision by Judge Gerber in In re BearingPoint Inc. reflects a preemptive posture some judges are taking in applying Stern to common law claims. In BearingPoint, Judge Gerber decided against retaining exclusive jurisdiction over a lawsuit based on state law for breaches of fiduciary duty reasoning among other things that “after Stern v. Marshall, this action, if still litigated here, would be subject to a considerably greater risk that it would be materially slowed by motion practice premised on my lack of constitutional authority to enter a final judgment[.]”
JPMorgan is the latest to jump on the Stern bandwagon, filing papers to move its’ lawsuit against Lehman Brothers Holdings Inc. out of Bankruptcy Court and into federal court. Judge James Peck, overseeing Lehman’s dispute with JPMorgan lamented that Stern has “weaponized [defendants]on the theory that which is not nailed down gets picked up.”
Limiting a judges’ authority is a significant move not to be taken lightly. Judge Robert Drain, also of the Southern District of New York, recently commented that the ruling causes bankruptcy judges to “doubt their reason for being.” Only time will tell how Stern will end up playing out in the courts but recent judicial reactions and public opinion seem to think that the Stern aftermath is going to be just as dramatic as the Ana Nicole Smith saga.