Whither the Bankruptcy Courts? Will They Wither? Supreme Court Ag...

Two years ago in Stern v Marshall, the Supreme Court surprised many observers by placing constitutional limits on the jurisdiction of the United States Bankruptcy Courts. The Court, in limiting the ability of a bankruptcy court judge to render a final judgment on a counterclaim against a party who had filed a claim against a debtor’s bankruptcy estate, re-opened separation of powers issues that most bankruptcy practitioners had thought settled since the mid-1980s. While the holding of Stern v Marshall itself was relatively narrow, the Court’s reasoning strongly suggested that further limitations on bankruptcy court authority could be in the offing. 

The Court has now granted certiorari in a Ninth Circuit case, Executive Benefits Insurance Agency v. Arkinson, that could lead the Court to circumscribe further or even eliminate the powers of bankruptcy court judges. 

The current structure of the United States Bankruptcy Courts dates back to the last complete overhaul of federal bankruptcy law in 1978. At that time, Congress created the bankruptcy courts pursuant to its authority under Article I of the Constitution to establish uniform laws on bankruptcy.  In 1982, the Supreme Court in Northern Pipeline Construction v. Marathon Pipe Line struck down on separation of powers grounds the 1978 grant of jurisdictional authority to bankruptcy court judges. The Court held in Northern Pipeline that the exercise of federal judicial power could only be undertaken by judges appointed under Article III of the Constitution, noting that the exceptions to that rule were territorial courts, military tribunals, and cases involving “public” rights. Northern Pipeline involved a breach of contract dispute commenced by a company that happened to be in bankruptcy. Although it struck down the ability of a non-Article III bankruptcy court judge to make a final determination in an action that clearly pertained to a “private” state common law right, the Court strongly suggested that the system of Article I bankruptcy courts was itself permissible, stating that “the restructuring of debtor-creditor relations, which is at the core of federal bankruptcy power,” in likelihood constituted the type of “public” right which could be heard and decided by an Article I judge. 

The issue of what constitutes a “public” right has never been clear. Some earlier cases had suggested that the scope of what constituted a “public” right was fairly narrow, involving only rights between individuals and the government. Other cases suggested broader parameters, and while the Court in Northern Pipeline did not expressly state that “the restructuring of debtor-creditor relations” under federal bankruptcy law actually constituted a “public” right, Congress accepted the Court’s evident suggestion and in 1984 granted new jurisdictional authority to the United States Bankruptcy Courts. Under the Bankruptcy Act of 1984, bankruptcy court judges became authorized to render final decisions in “core” matters under the Bankruptcy Code, and to hear and submit findings of fact and conclusions of law to Article III district court judgess with respect to “non-core” matters. Although the Court never ruled on the constitutionality of the “core” and “non-core” bankruptcy jurisdictional construct, in other cases involving Article I tribunals the Court took an expansive and pragmatic view of the “public” rights doctrine, one that certainly appeared to be broad enough to encompass the list of “core” matters enumerated in the Bankruptcy Act of 1984, and the separation of powers issues raised by Northern Pipeline appeared to have been laid to rest.                                 

For this reason, the Court’s decision in Stern v. Marshall, a case that arose out of the endless litigation between Anna Nicole Smith and the son of her late husband, stunned most bankruptcy practitioners. At some point Ms. Smith had filed for bankruptcy and Mr. Marshall filed a claim against her bankruptcy estate. The particular issue before the Court involved a counterclaim based on tortious interference filed by Ms. Smith against Mr. Marshall.  Among the “core” matters designated by Congress in 1984 as to which bankruptcy court judges could make final determinations were “counterclaims . . .  against persons filing claims against the estate.” The Court, reverting back to a narrow view of “public” rights, held that Congress could not authorize a non-Article III court to render a final determination on a state law counterclaim. 

 While the Court’s opinion in Stern v. Marshall purported to be limited, even a cursory analysis of the Court’s constricted view of “public” rights made clear that other aspects of the Bankruptcy Act of 1984 similarly must be constitutionally suspect. The Ninth Circuit Court of Appeals in Executive Benefits Insurance Agency noted that an earlier Ninth Circuit opinion that had upheld the constitutionality of the “core” and “non-core” construct “cannot be reconciled with the reasoning in Stern” and thus was no longer good law. 

The Ninth Circuit in Executive Benefits Insurance Agency held that a fraudulent transfer action, although listed as a “core” matter under the Bankruptcy Act of 1984, could not fit within the cramped parameters of a “public” right under Stern v. Marshall and could not be adjudicated by a non-Article III judge. However, it also held that the right to have a matter heard by an Article III judge was an individual right that could be waived, and that the defendant had implicitly consented to bankruptcy court jurisdiction. The Ninth Circuit further held that the bankruptcy court could prepare recommendations for review by the district court even though the Bankruptcy Act of 1984 does not explicitly authorize bankruptcy judges to submit proposed findings and conclusions in a “core” proceeding.

The Supreme Court has granted certiorari with respect to these last two issues. It must first decide whether Article III permits non-Article III courts such as bankruptcy courts to exercise judicial power based on individual consent. If so, the Court will then consider whether implied consent is sufficient to satisfy Article III, and whether a bankruptcy judge may submit proposed findings of fact and conclusions of law for review by a district court in a core proceeding. 

It may be that the Court will rule on relatively narrow grounds. However, the possibility exists that the Court will drop the other shoe that has been hanging since Stern v. Marshall. If the “public” rights doctrine is indeed as narrow as the Court has suggested, and only encompasses rights between individuals and the government, it is questionable whether non-Article III bankruptcy court judges can constitutionally render final decisions on any of the “core” matters set forth in the Bankruptcy Act of 1984. Executive Benefits Insurance Agency will undoubtedly be one of the most closely watched cases on the Supreme Court’s 2013-14 docket.