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A Survey of Cases Interpreting the Stern Decision, Part IV

By Omar J. Alaniz – December 10, 2012


This article is the fourth in a multipart series that provides an overview of trends in how courts are interpreting Stern v. Marshall. Read Part I, Part II, and Part III.


This fourth part in the series is a synthesis and discussion of the cases that have meaningfully discussed Stern from July 16, 2012, through October 15, 2012, although it includes the Sixth Circuit’s October 26, 2012, decision in Machine & Fabrication, LLC v. Stone (In re Waldman). To avoid redundancy, this article includes citations to Parts I–III, and it refers to a chart that catalogues all cases that have meaningfully discussed Stern from September 1, 2011, through October 15, 2012.


Consent
Is Consent Even Possible after Stern?
The substantial majority of cases have held that Stern did not affect a party’s ability to consent to bankruptcy court adjudication under 28 U.S.C. § 157(c)(2), although, as discussed below, the issue of what constitutes consent divides courts. See Part I at 9–11; Part II at 9–10; Part III at 7–9. However, the Sixth Circuit Court of Appeals in Machine & Fabrication, LLC v. Stone (In re Waldman), No. 10-6497, 2012 WL 5275241 (6th Cir. Oct. 26, 2012), held that the bankruptcy court did not have the constitutional authority to enter a final order on fraud claims that an individual Chapter 11 debtor brought against a creditor. In Waldman, the creditor did not file a proof of claim, but the debtor scheduled a disputed claim for the creditor, objected to the claim, and sought affirmative relief against the creditor for fraud. The creditor conceded that the matter was a core proceeding, filed a counterclaim, and did not challenge the bankruptcy court’s authority to enter a final order in the adversary proceeding until the appeal stage. After determining that the “[the creditor] had perpetrated upon [the debtor] one of the most egregious frauds the court had ever encountered,” the bankruptcy court entered a judgment in excess of $3 million against the creditor for compensatory and punitive damages.


The Sixth Circuit reasoned that Article III mandates that the judicial power of the United States be vested in Article III judges. Id. at *5 (citing Stern, 131 S. Ct. at 2609). The court stated that “[t]o the extent that Congress can shift the judicial Power to judges without those protections, the Judicial Branch is weaker and less independent than it is supposed to be.” Id. (citing Commodity Futures Trading Comm’n v. Shor, 478, U.S. 833, 850 (1986)). The court ultimately determined that the creditor’s objection to the bankruptcy court’s adjudication implicates not only his personal rights but also the structural principle advanced by Article III and that a litigant cannot waive such principle.


The Sixth Circuit’s decision in Waldman may be in conflict with its precedent in Bell & Beckwith v. United States, 766 F.2d 910 (6th Cir. 1985), in which the Sixth Circuit dismissed a litigant’s challenge to the magistrate consent statute (28 U.S.C. § 636(c)). In Bell & Beckwith, the parties consented to the magistrate judge hearing and determining their dispute. After judgment, the disappointed party challenged the constitutionality of 28 U.S.C. § 636(c). Ironically, the appellant argued that section 636(c) was unconstitutional under a relatively new decision of the Supreme Court: Northern Pipeline Construction Co. v. Marathon Pipeline, 458 U.S. 50 (1982). The appellant argued that under Marathon, the magistrate was not authorized to exercise the power of an Article III judge. But the Sixth Circuit determined that the argument was without merit because unlike in Marathon, the parties had consented. The Sixth Circuit cited other circuit court decisions holding that 28 U.S.C. § 636(c) was constitutional, including the Ninth Circuit’s en banc decision in Pacemaker Diagnostic Clinic of America, Inc. v. Instromedix, Inc., 725 F.2d 537 (9th Cir. 1984).


Pacemaker confronted the very same constitutional concern that the Sixth Circuit in Waldman recently addressed—but in a much more thorough fashion. As in Waldman, the Ninth Circuit acknowledged that constitutional protections such as separation of powers cannot be waived by affected private parties. Id. at 544. But the court also noted that the Supreme Court has consistently upheld a party’s ability to waive a “personal” right to have its matter heard by an Article III judge. Thus, the court had to determine whether the magistrate consent statute raised a separation of powers concern. The Ninth Circuit opined that the standard for determining whether there is an encroachment of the separation of powers doctrine is whether the statute “prevents or substantially impairs performance by the branch of its essential role in the constitutional system.” Id. (citing Nixon v. Adm’r of Gen. Servs., 433 U.S. 425, 443 (1977)). After considering how the Article III courts and the magistrate courts interact, the Ninth Circuit was satisfied that Article III judges maintain sufficient control over the magistrate judges to ameliorate any separation of power concerns. See id. at 545. Accordingly, the Ninth Circuit held that private parties are constitutionally permitted to waive their right to Article III adjudication in the magistrate context and that 28 U.S.C. § 636(c) is therefore constitutional.


The bankruptcy court in Ardi Ltd. Partnership v. River Entertainment Co. (In re River Entertainment Co.), 467 B.R. 808 (Bankr. W.D. Pa. 2012), recently relied on Pacemaker to determine that Article III judges have sufficient control over bankruptcy judges such that the structural protections of Article III are not undermined by 28 U.S.C. § 157(c)(2). Thus, River Entertainment is squarely at odds with the Sixth Circuit’s opinion in Waldman.

The River Entertainment decision contains the most thorough discussion of the consent issue since Stern was decided, including Waldman. See River Entertainment, 467 B.R. at 816–818. The River Entertainment case involved a conversion action that was removed from state court. During the initial eight months following removal, the plaintiff made statements in its pleadings and on the record that the bankruptcy court construed as the plaintiff’s implied consent to bankruptcy court adjudication. Id. at 824. Following Stern, the plaintiff challenged the bankruptcy court’s constitutional authority to enter a final judgment on its claims and the defendant’s counterclaims. Id. at 816.


The bankruptcy court in River Entertainment ultimately determined that the decision in Stern did not alter a bankruptcy court’s ability to adjudicate non-core matters by party consent. Citing Pacemaker, the bankruptcy court determined that many of the same reasons articulated by the Ninth Circuit to demonstrate that Article III courts maintain sufficient control over magistrate judges are present in the bankruptcy court context as well. Id. at 819. For example, Article III judges have control over the appointment of bankruptcy judges. Moreover, the district court has the ability to withdraw the reference of the bankruptcy case or any proceeding at any time sua sponte. Accordingly, the bankruptcy court determined that 28 U.S.C. § 157(c)(2) passes constitutional muster.


Must Consent Be Explicit or Can It Be Implied from Conduct in Litigation?

The River Entertainment decision raised an issue that has divided courts on consent. Some courts believe that consent cannot be implied by conduct in litigation, whereas other courts believe that consent can be implied. It is worth noting that the creditor in Waldman arguably consented expressly by conceding that the matter was a core proceeding and also consented by its conduct when it filed a counterclaim and failed to raise any concerns about the bankruptcy court’s authority until after judgment was entered.


A few courts issued decisions during the period from July 16 through October 15, 2012, holding that consent can be implied by conduct in litigation even after Stern. For example, in Acevedo v. Wells Fargo Bank, N.A. (In re Acevedo), 472 B.R. 360 (Bankr. D. Mass. 2012), the bankruptcy court determined that the defendants implicitly consented to entry of final orders in an adversary proceeding containing a mix of core and non-core claims because the defendants moved for summary judgment on all counts without raising any authority issues. See also Bachrach Clothing, Inc. v. Bachrach (In re Bachrach Clothing, Inc.), Adv. No. 08-00726, 2012 WL 4838998 (Bankr. N.D. Ill. Oct. 10, 2012) (determining that defendants implicitly consented to bankruptcy court adjudication after having filed a jointly prepared stipulation for trial describing the adversary proceeding as a core proceeding).


In Segarra-Miranda v. Perez-Padro, No. 12-1026, 2012 WL 4018521 (D.P.R. Sept. 13, 2012), the district court advanced a statutory construction argument as to why consent may be implied by litigation conduct. The court reasoned that unlike section 157(e), which refers to “express consent,” section 157(c)(2) does not contain the same qualification. Id. at *5. The court also noted that Stern nowhere mentions that consent must be express and that prior First Circuit precedent, as well as other circuits’ precedent, establishes that consent can be implied by conduct.


In French v. Johnson Law Group (In re Kohlenberg), Adv. No. 10-3390, 2012 WL 3292854 (Bankr. N.D. Ohio Aug. 10, 2012), the defendant in an action brought by the Chapter 7 trustee did not answer or appear at a hearing on a motion for default judgment. But the bankruptcy court would not enter the default order on the non-core claims based on the defendant’s default. The court would not infer the defendant’s consent to the bankruptcy court’s entry of final orders in the adversary proceeding from the defendant’s default. Instead, the bankruptcy court submitted proposed findings of fact and conclusions of law to the district court. Id. at *10.


Adversary Proceedings—Avoidance Actions
Courts continue to differ as to whether a bankruptcy court is permitted enter a final order in adversary proceedings involving avoidance actions. Generally, the split between the courts can be divided into an expansive view and a narrow view. See Part I at 3–5; Part II at 6–7; Part III at 2–4. If a court does not state an affirmative position on the issue—for example, if a court merely denies a motion to dismiss the action—the decision is designated as “neutral” in the accompanying chart.


Expansive View
The arguments supporting the expansive view remain unchanged. See Part I at 4, 12–13; Part II at 6; Part III at 3. These cases generally rely on Granfinanciera just as much as on Stern. In Gibson v. Tucker (In re G & S Livestock Co.), No. 2:12-cv-0095, 2012 WL 3867109, at *8 (S.D. Ind. Sept. 5, 2012), the district court opined that by repeatedly analogizing the counterclaim in Stern to a trustee’s fraudulent conveyance claim in Granfinanciera, the Supreme Court made clear that there is a constitutional right to have an Article III court enter judgment on a trustee’s fraudulent transfer conveyance claim. See also Rosenberg v. Bookstein, No. 2:12-cv-00627, 2012 WL 4361255, at *3 (D. Nev. Sept. 21, 2012) (holding that a belief that bankruptcy courts have constitutional authority to determine fraudulent transfer actions “ignore[s] the logic of Stern as well as . . . Granfinanciera”). The district court in G & S Livestock further explained that a fraudulent transfer claim exists without regard to a bankruptcy case and that the claim is intended to increase payouts to creditors under the confirmed plan, not to place the claims in a hierarchical order for a share of the bankruptcy res.


The expansive view also was adopted during the period from July 16 through October 15, 2012, in FTI Consulting, Inc. v. Merit Management Group, LP, 476 B.R. 535 (N.D. Ill. 2012), and in Lehman Brothers Holdings Inc. v. JPMorgan Chase Bank (In re Lehman Brothers Holdings Inc.), No. 11 Civ. 6760, 2012 WL 4559735, at *10–11 (S.D.N.Y. Sept. 28, 2012) (section 548 action).


Narrow View
The narrow view of Stern is that Stern does not alter the bankruptcy court’s authority to enter a final order in adversary proceedings involving avoidance actions. See Part I at 4–5; Part II at 6–7; Part III at 3–4.


The bankruptcy court’s decision in KHI Liquidating Trust v. Wisenbaker Builder Services (In re Kimball Hall, Inc.), Adv. No. 10-00824, 2012 WL 4867409 (Bankr. N.D. Ill. Oct. 12, 2012), advanced some novel arguments supporting the narrow view. In this case, the trustee filed a fraudulent transfer action against the defendant under sections 544(b) and 548. The bankruptcy court reasoned that section 544 fraudulent transfer actions serve the same purpose as section 548 actions. The court opined that fraudulent transfer law is “actually steeped in bankruptcy law.” Id. at *12. The court explained that claims for recovery or avoidance of fraudulent transfers have been a part of insolvency since 1570. The court then traced the evolution of fraudulent transfer law from the Statute of Elizabeth through the U.S. Bankruptcy Code. The court concluded that “the resemblance between bankruptcy fraudulent transfer claims and state law fraudulent transfer claims is because the state claims have as their source, and are modeled after, the bankruptcy claims.” Id. Thus, the bankruptcy court appears to be turning the logic of Granfinanciera on its head. The bankruptcy court further reasoned that adjudicating fraudulent transfer claims is a core federal bankruptcy power and that actions to avoid these transfers are integral to the debtor-creditor relationship. Id. at *13. The bankruptcy court in Andrews v. RBL, L.L.C. (In re Vista Bella, Inc.) had similar reasoning. Adv. No. 12–00060, 2012 WL 3778956 (Bankr. S.D. Ala. Aug. 30, 2012) (holding that it had constitutional authority to enter a final order in an adversary proceeding containing section 544, 547, and 548 actions).


Other courts supporting the narrow view in the period from July 16 through October 15, 2012, include Cifelli v. Blue Star Residential, LLC (In re Miles), 477 B.R. 266 (Bankr. N.D. Ga. 2012) (section 548 action), and Bakst v. United States (In re Kane & Kane), Adv. No. 10-01022, 2012 WL 2899960 (Bankr. S.D. Fla. July 16, 2012) (constructive fraudulent transfer; in dicta).


When the Defendant Has Filed a Proof of Claim
The Sixth Circuit Court of Appeals in Onkyo Europe Electronics GMBH v. Global Technovations Inc. (In re Global Technovations Inc.), No. 2012 WL 4017386 (6th Cir. Sept. 13, 2012), determined that the bankruptcy court had the constitutional authority to determine a fraudulent transfer claim. However, the defendant had filed a proof of claim; accordingly, it was unquestionable that the bankruptcy court had the authority to decide the matter. Stern did not overrule Katchen v. Landy, 382 U.S. 323, 329–30 (1966), and Langenkamp v. Culp, 498 U.S. 42, 45 (1990); in fact, the Supreme Court in Stern cited those cases. 131 S. Ct. at 2616.


In Katchen and Langenkamp, the Supreme Court held that because section 502(d) requires the bankruptcy court to disallow a claim of an entity from which property is recoverable, inter alia, as a fraudulent transfer, the defendant’s filing of the proof of claim supplies the bankruptcy court with authority to rule on the fraudulent transfer claim. Stern, 131 S. Ct. at 2616. Accordingly, Global Technovations falls in the neutral category. See also Wallach v. Rothstein (In re Nanodynamics, Inc.), 474 B.R. 422 (Bankr. W.D.N.Y. 2012) (defendant filed proof of claim); U.S. Bank Nat’l Assoc., Tr. of the Idearc Inc. Litig. Trust v. Verizon Commc’ns Inc., No. 3:10-CV-1842-G, 2012 WL 3034707 (N.D. Tex. July 25, 2012) (same).


However, in Bachrach Clothing, Inc. v. Bachrach (In re Bachrach Clothing, Inc.), Adv. No. 08-00726, 2012 WL 4838998 (Bankr. N.D. Ill. Oct. 10, 2012), the bankruptcy court reasoned that the only way to harmonize Stern with Granfinanciera and Langenkamp is to conclude that the filing of a proof of claim does not automatically authorize the bankruptcy court to enter a final judgment against the creditor. The bankruptcy court opined that post-Stern, the bankruptcy court will have authority to rule on the claim only if the counterclaim stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process. Id. at *2. The bankruptcy court ultimately determined that there was a close relationship between the fraudulent transfer counts and the claims allowance process because of section 502(d) and that the bankruptcy court had constitutional authority to rule on the fraudulent transfer action because of the creditor’s filing of the claim. But this is precisely the rationale underlying Langenkamp (and Katchen). Perhaps the harmonization between Stern, Granfinanciera, and Langenkamp that the bankruptcy court in Bachrach seeks is that the filing of a proof of claim does not automatically authorize the bankruptcy court to enter a final judgment against the creditor—unless the counterclaim is an action of the type listed in section 502(d) (which includes sections 544, 547, and 548).


Section 549 Actions
The post-Stern cases discussing avoidance actions generally focus on section 544 and 548 actions. There is little case law discussing whether Stern affects the bankruptcy court’s ability to hear and determine section 549 actions. Indeed, this was one of the two issues in the fact pattern for the 2012 Hon. Conrad B. Duberstein Bankruptcy Moot Court Competition.


In Murphy v. Felice (In re Felice), Adv. No. 08-01355, 2012 WL 4757791 (Bankr. D. Mass. Oct. 5, 2012), the bankruptcy court determined that it had constitutional authority to enter a final order in a section 549 action. The court reasoned that unlike the counterclaim in Stern, the recovery of an unauthorized post-petition transfer will not “augment the estate.” Id. at *20. The court also determined that the count to recover an unauthorized post-petition transfer stems from the Bankruptcy Code. Id. at *21. Moreover, the court explained that the property recovered is already property of the estate, and “the jurisdiction of courts adjudicating rights in the bankrupt estate include[s] the power to issue compulsory orders to facilitate the administration and distribution of the res.” Id. (quoting Cent. Va. Cmty. College v. Katz, 546 U.S. 356, 362 (2000)).


Adversary Proceedings—Non-Avoidance Actions
An adversary proceeding may contain a variety of causes of action based on federal law, state law, or both. In some adversary proceedings, a court may determine that the bankruptcy court has the statutory and constitutional authority to determine certain claims while it may lack the requisite authority with respect to other claims in the proceeding. See, e.g., TP, Inc. v. Bank of Am., N.A. (In re TP, Inc.), Adv. No. 11-00112, 2012 WL 4471539 (Bankr. E.D.N.C. Sept. 26, 2012).


One of the biggest misconceptions about Stern is that bankruptcy courts can no longer rule on state law matters. The Supreme Court explained that “[a]s we stated in Butner, property interests are created and defined by state law, and unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding.” Travelers Cas. & Sur. Co. of Am. v. Pac. Gas and Elec. Co., 549 U.S. 443, 451 (2007) (quoting Butner v. United States, 440 U.S. 48, 55 (1979)). Bankruptcy courts are frequently required to interpret state law to rule on matters involving the restructuring of the debtor-creditor relationship—matters that the Supreme Court has acknowledged are at the “core” of the bankruptcy court’s power. See Stern v. Marshall, 131 S. Ct. at 2605 (citing Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 71 (1982)). See also Apperson v. Bleckner (In re Batt), No. 12-MC-009, 2012 WL 4324930 (W.D. Ky. Sept. 20, 2012) (“Stern does not bar the exercise of Bankruptcy Court’s jurisdiction in any and all circumstances where a party to an adversary proceeding has not filed a proof of claim, or where the issue in an adversary proceeding is a matter of state law.”).


In PHH Mortgage Co v. Corzin, No. 5:11CV1939, 2012 WL 4023440 (N.D. Ohio Sept. 12, 2012), the district court determined that the bankruptcy court had constitutional authority to rule in adversary proceedings regarding avoidance of transfer and determination of extent, priority, and validity of lien. The district court held that this action was “not an instance of the application of state law that only Article III judges can resolve.” Id. at *3. In a similar case, a bankruptcy court determined it had authority to rule on the validity of a creditor’s mortgage and secured nature of claim. Pulaski v. Dakota Fin., LLC (In re Pulaski), 475 B.R. 681 (Bankr. E.D. Wis. 2012). The court reasoned that the “essence of the claims allowance process is the determination of the claim’s validity—i.e., its conformity to the requirements of applicable law.” Id. at *5.


In Newco Energy Inc. v. Energytec, Inc., No. 4:11-cv-737, 2012 WL 432708 (E.D. Tex. Sept. 30, 2012), the district court determined that Stern did not prevent the bankruptcy court from determining whether a bankruptcy sale transferred property free and clear of a party’s interests under section 363(f) even though the bankruptcy court was required to analyze the party’s interest under state law.


In Lehman Brothers Holdings Inc. v. JPMorgan Chase Bank (In re Lehman Brothers Holdings Inc.), No. 11 Civ. 6760, 2012 WL 4559735, at *5 (S.D.N.Y. Sept. 28, 2012), the debtors filed an adversary proceeding containing 49 causes of action. Several of them were state law actions that the district court determined would not need to be ruled on by the bankruptcy court to determine the defendant’s proof of claim. Id. at *9. The district court also determined that the public rights exception did not apply. “Speaking loosely, public rights are: (1) rights created by federal law, to which the political branches are free to attach conditions; (2) claims tied up inextricably with such rights; or (3) ‘matters that historically could have been determined exclusively by the Executive and Legislative Branches.’” Id. at *7 (citing Dev. Specialists, Inc. v. Akin Gump Strauss Hauer & Feld LLP, 462 B.R. 457, 464 (quoting Stern, 131 S. Ct. at 2611–13)). Cf. United States v. Bond, No. 11 Civ. 5608, 2012 WL 4089648 (E.D.N.Y. Sept. 17, 2012) (suit against the Internal Revenue Service fell squarely within the definition of public rights, i.e., a suit between the United States government and a private party).


Contested Matters
During the period from July 16 through October 15, 2012, several courts determined that Stern did not prevent the bankruptcy court from issuing final orders in contested matters. E.g., In re Garrett-Beck Corp., No. 09-37774, 2012 WL 3727318 (Bankr. S.D. Tex. Aug. 27, 2012) (motion to determine validity, priority, or extent of lien); In re Jackson, No. 06-36268, 2012 WL 3071218 (Bankr. S.D. Tex. July 27, 2012) (matter concerning the debtor’s failure to disclose interest in schedules under section 521); In re Stout III, 474 B.R. 803 (Bankr. S.D. Tex. 2012) (claim objection); Kraken Inv. Ltd. v. Jacobs (In re Salander-O’Reilly Galleries, LLC), 475 B.R. 9 (S.D.N.Y. 2012) (determination of property of the estate); Murphy v. Felice (In re Felice), Adv. No. 08-01355, 2012 WL 4757791 (Bankr. D. Mass. Oct. 5, 2012) (determination of whether spendthrift trust excludes debtor’s interest in trust from property of the estate under section 541(c)(2); same for determination of exemption); Murrin v. Hanson (In re Murrin), 477 B.R. 99 (D. Minn. 2012) (automatic stay); Velo Holdings Inc. v. Paymentech, LLC (In re Velo Holdings Inc.), 475 B.R. 367 (Bankr. S.D.N.Y. 2012) (in adversary proceeding, bankruptcy court determined it had constitutional authority to determine whether agreements were executory contracts and whether certain agreements were property of the estate); In re Lack’s Stores, Inc., No. 10-60149, 2012 WL 3043093 (Bankr. S.D. Tex. July 25, 2012) (rejection of damages claim).


Counterclaims
Although they are buried in the abundance of post-Stern case law, there are actually matters in which Stern is unquestionably relevant—matters in which a bankruptcy court must determine whether it has the constitutional authority to rule on a bankruptcy estate’s counterclaims against a creditor’s proof of claim.


In TP, Inc. v. Bank of America, N.A. (In re TP, Inc.), the bankruptcy court explained that the Stern test is whether the counterclaim stems from the bankruptcy itself or whether the issue would “necessarily be resolved in” the claims allowance process. Adv. No. 11-00112, 2012 WL 4471539, at *8 (Bankr. E.D.N.C. Sept. 26, 2012) (quoting Stern v. Marshall, 131 S. Ct. at 2618). The bankruptcy court put a gloss on the second prong of the Stern test, reasoning that a counterclaim by the estate that seeks affirmative relief but does not directly modify the amount claimed would not qualify as a claim to be resolved in the ruling on the proof of claim. Id. at *9. In this case, a creditor filed a proof of claim for the debtor’s alleged breach of a promissory note. The debtor filed 10 counterclaims. The bankruptcy court ultimately determined that it had constitutional authority to determine some, but not all, of the estate’s counterclaims. For example, the court determined it could not rule on the counterclaims for constructive fraud or breach of fiduciary because the outcome of those counterclaims would not affect the calculation of the amount of the creditor’s claim. Id. at *9–10. But the court determined that it would rule on the counterclaims for fraud in the inducement and rescission because the counterclaims attacked the enforceability of the loan documents that formed the basis of the creditor’s proof of claim. Id. at *10.


The bankruptcy court in Somerset Properties SPE, LLC v. LNR Partners, Inc. (In re Somerset Properties SPE, LLC), Adv. No. 11-00053, 2012 WL 3877791 (Bankr. E.D.N.C. Sept. 6, 2012), also discussed the second prong of the Stern test. The court explained that under the second prong, courts typically look to see whether a common nucleus of law and fact inextricably intertwine the claim and counterclaims. Id. at *8. The court further reasoned that for a counterclaim to be necessarily resolved in a ruling on the proof of claim, the relationship must be such that resolution of the counterclaim would alter the amount sought by the claimant.


Dischargeability
Dischargeability actions present an interesting Stern question. Most would agree that the issue of whether a debt is dischargeable in bankruptcy is a core proceeding. This may be because the matter arises under title 11 (11 U.S.C. § 523) or arises in a title 11 case (dischargeability has no existence outside a bankruptcy case) and thus is a core proceeding under 28 U.S.C. § 157(b)(1); see also 28 U.S.C. § 157(b)(2)(I). Dischargeability also implicates a bankruptcy court’s in rem jurisdiction. See Cent. Va. Cmty. Coll. v. Katz, 546 U.S. 356, 362 (2006). But what if the creditor’s claim was not liquidated prior to the bankruptcy filing? Is it constitutionally permissible for the bankruptcy court to enter a final judgment on a non-core claim (e.g., a state law claim) and then determine whether that claim is dischargeable?


Part III in this series discussed cases addressing whether a bankruptcy court has constitutional authority to enter a money judgment in connection with a dischargeability proceeding. See Part III at 9–10. The rationale underlying these cases is that binding circuit court decisions have concluded that the bankruptcy courts do have such authority and that Stern does not alter these holdings. See, e.g., Gila Reg’l Med. Ctr. v. Lobera (In re Lobera), Adv. No. 11-1112S, 2012 WL 3263730 (Bankr. D.N.M. Aug. 9, 2012) (citing Tenth Circuit precedent). The courts reason that the issue in Stern did not concern a bankruptcy court’s ability to enter a money judgment in connection with a dischargeability proceeding. See also Eaton v. Ford Motor Credit Co., LLC, No. 3:11-1029, 2012 WL 3579644 (M.D. Tenn. Aug. 17, 2012) (opining that the scope of a debtor’s discharge is a fundamental part of the bankruptcy process, which includes determination of debt); Lawson v. Conley (In re Conley), Adv. No. 10-3169, 2012 WL 4845954 (Bankr. S.D. Ohio Oct. 5, 2012) (“[B]inding circuit precedent . . . cannot be lightly determined to be overturned based upon a broad interpretation of a Supreme Court decision.”).


In Sheets v. Carter (In re Carter), No. 11-5157, 2012 WL 3440431 (Bankr. M.D. Ga. Aug. 15, 2012), the bankruptcy court determined whether it was able to retain jurisdiction over a non-dischargeability proceeding for purposes of entering a money judgment when the debtor had waived the discharge. The bankruptcy court reasoned that its authority for entering a money judgment in a dischargeability action was predicated on the matter being wrapped up in a dischargeability proceeding. Id. at *3. But dischargeability was no longer an issue because the debtor waived his discharge. After determining that the resolution of the state law claims underlying the dischargeability action would have no impact on the estate, the court dismissed the adversary proceeding. Id. at *4. But Carter is not inconsistent with the other post-Stern dischargeability cases because the debtors did not waive their discharge in the other cases.


Statutory Gap
The “statutory gap” theory is that Stern has left a third category of matters falling within the bankruptcy court’s jurisdiction: “core but unconstitutional.” The concern is that if a proceeding is “core” under section 157(b) and yet the bankruptcy court is somehow not constitutionally permitted to determine the matter (as in Stern), then section 157(c)(1) does not appear to supply the bankruptcy court with the authority to submit proposed findings of fact and conclusions of law because the statute refers only to non-core matters. This concern has been universally rejected in every case decided since September 2011. See Part I at 8–9; Part II at 12–13; Part III at 10–12.


As discussed in Part II, the Seventh Circuit Court of Appeals in Ortiz v. Aurora Health Care, Inc. (In re Ortiz), 665 F.3d 906 (7th Cir. 2011), held that even though the bankruptcy court had statutory authority over the Chapter 13 debtors’ actions against a health care provider that appended unredacted medical records to its proof of claims, the bankruptcy court lacked the constitutional authority to do so. But on appeal from the remand, the district court held that it was not error for the bankruptcy court to submit proposed findings of fact and conclusions of law on the mater. No. 12-C-0295, 2012 WL 3574066 (E.D. Wis. Aug. 21, 2012).


The district court in Ortiz is joined by several other courts that have held that there is no statutory gap preventing the bankruptcy court from submitting proposed findings of fact and conclusions of law when to do so arguably conflicts with section 157(c)(1). See FTI Consulting, Inc. v. Merit Mgmt. Grp., LP, 476 B.R. 535, 539 (N.D. Ill. 2012) (albeit concluding that the bankruptcy court lacks constitutional authority to enter a final order on a fraudulent transfer action); Cifelli v. Blue Star Residential, LLC (In re Miles), 477 B.R. 266, 271 (Bankr. N.D. Ga. 2012); Bank of Montreal v. SK Foods, LLC, 476 B.R. 588, 596 (N.D. Cal. 2012); Neilson v. Monterey Cnty. Bank (In re Cedar Funding, Inc.), No. C-12-00643, 2012 WL 3309683, at *8 (N.D. Cal. Aug. 13, 2012); Greenspan v. Paul Hastings Janofsky & Walker LLP, No. C 12-01148, 2012 WL 3283516 (N.D. Cal. Aug. 10, 2012) (denying motion to withdraw reference); Lehman Bros. Holdings Inc. v. JPMorgan Chase Bank (In re Lehman Bros. Holdings Inc.), No. 11 Civ. 6760, 2012 WL 4559735, at *7 (S.D.N.Y. Sept. 28, 2012) (same); Rosenberg v. Bookstein, No. 2:12-cv-00627, 2012 WL 4361255 (D. Nev. Sept. 21, 2012) (same); Kriegman v. Fraser Milner Casgrain, LLP (In re LLS Am., LLC), No. CV-12-486, 2012 WL 4847000 (E.D. Wash. Oct. 11, 2012) (same); KHI Liquidating Trust v. Wisenbaker Builder Servs. (In re Kimball Hall, Inc.), Adv. No. 10-00824, 2012 WL 4867409 (Bankr. N.D. Ill. Oct. 12, 2012).


The statutory gap is addressed in a number of cases in which litigants moved to withdraw the reference based on a Stern-type argument. But the district courts continue to deny motions premised on Stern arguments even for matters that are clearly non-core and where the movant has asserted (or has the right to assert) a jury demand.


Withdrawal of the Reference
Withdrawal of the reference continues to be a popular litigation tool in this post-Stern world. A factor that district courts have historically considered in determining whether to withdraw the reference is whether the matter is a core or non-core matter. See, e.g., In re Orion Pictures Corp., 4 F.3d 1095, 1101 (2d Cir. 1993). But in Lehman Brothers Holdings Inc. v. JPMorgan Chase Bank (In re Lehman Brothers Holdings Inc.), No. 11 Civ. 6760, 2012 WL 4559735, at *7 (S.D.N.Y. Sept. 28, 2012), the district court opined that post-Stern, the core versus non-core distinction is no longer relevant. In its place, the relevant consideration is whether the bankruptcy court has constitutional authority to decide the matter.


In Lehman Brothers, the district court determined that the bankruptcy court lacked the constitutional authority to determine the majority of the 49 counts in the complaint. Moreover, the defendant demanded a jury. Nevertheless, the district court denied the motion to withdraw the reference. The district court reasoned that the bankruptcy court oversaw the administration of the three year-long bankruptcy case and that the bankruptcy court had a wealth of expertise in fraudulent transfer matters. Id. at *14. Accordingly, the district court determined that it would not withdraw the reference until the matter was ready for trial. Id. at *16. See also Rosenberg v. Bookstein, No. 2:12-cv-00627, 2012 WL 4361255 (D. Nev. Sept. 21, 2012) (motion to withdraw reference was premature).


In Manning v. Methodist Hospital, Inc. (In re Merrillville Surgery Center), No. 2:12-cv-254, 2012 WL 3732855 (N.D. Ind. Aug. 28, 2012), the district court determined that withdrawal of the reference was appropriate in avoidance actions filed under sections 544, 547, and 548, because the defendant asserted a jury trial right. But the district court noted that withdrawal of the reference in jury cases is not required to be immediate. The district court withheld decision on withdrawal of the reference pending supplementation of the record to allow the district court to consider factors in determining when reference should be withdrawn. In Parks v. Consumer Law Associates, LLC (In re Stahl), Adv. No. 10-05200, 2012 WL 3758833 (Bankr. D. Kan. July 19, 2012), the bankruptcy court recommended withdrawal of the reference in an adversary proceeding containing a mix of core and non-core claims. See also Parks v. Persels & Assocs., LLC (In re Ballway), Adv. No. 11-05016, 2012 WL 3595091 (Bankr. D. Kan. July 19, 2012). The defendant did not file a proof of claim and demanded a jury trial. The bankruptcy court determined that the non-core claims predominated the adversary proceeding and that judicial economy favored withdrawal of the reference. See also Morris v. Persels & Assocs., LLC (In re Good), Adv. No, 12-5052, 2012 WL 3066885 (Bankr. D. Kan. July 27, 2012) (adversary proceeding contained a mix of bankruptcy and state law claims, but state law claims predominated; defendants did not file proofs of claim and demanded jury trial).


Other cases confronting withdrawal of the reference requests include Loomis v. Hunter, Humphrey & Yavitz, PLC, No. CV-12-0586, 2012 WL 3064496 (D. Ariz. July 27, 2012) (denying withdrawal of the reference even though the district court determined that bankruptcy court could not decide the matter on a final basis); TTOD Liquidation v. Lim (In re Dott Acquisition, LLC), No. 12-12133, 2012 WL 3257882 (E.D. Mich. July 25, 2012) (granting withdrawal of the reference in adversary proceeding containing fraudulent transfer claims and various state law causes of action after determining the bankruptcy court lacked constitutional authority to decide them).


Keywords: bankruptcy and insolvency litigation, jurisdiction, core, consent, jury, dischargeability, statutory gap, constitutional authority


Omar J. Alaniz is a senior associate at Baker Botts L.L.P. in Dallas, Texas.



 
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