The Bottom Line:
It’s not often (if ever) that one can logically connect Playboy Magazine with bankruptcy court jurisdiction, but years after her passing, a former Playmate of the Year (1993) did just that. The U.S. Supreme Court, in Stern v. Marshall, No. 10-179, 564 U.S. __ (June 23, 2011), ruled (in a 5-4 vote) that a bankruptcy court judge did not have the constitutional authority to enter a final judgment on a counterclaim that was insufficiently related to the underlying proof of claim filed in the debtor’s bankruptcy proceedings. The case goes to the delegation of authority under the 1984 Amendments to the Bankruptcy Code, which created the concept of “core” claims – upon which a bankruptcy judge could make final factual determinations subject to appellate review – and “non-core” claims – upon which (unless the parties consent otherwise) the bankruptcy court’s decisions of law and fact are not final and are subject to de novo review on appeal. In Stern v Marshall, the Court initially examined whether the bankruptcy court had proper statutory authority to enter a final judgment on a “counterclaim,” under 28 U.S.C. § 157(b)(2), and found that Congress did, indeed, grant bankruptcy court judges the authority to enter final judgments on all “counterclaims” filed by debtors in response to claims filed in the bankruptcy case. However, the Supreme Court proceeded to hold that Congress lacked the ability to actually grant such authority over all counterclaims to bankruptcy court judges pursuant to Article III of the Constitution. The Supreme Court’s ruling centered around the fact that bankruptcy court judges, who are not Article III judges and are only appointed to limited (14-year) terms, only have the authority to enter final judgments on “core” counterclaims, and not to “non-core” counterclaims based purely on state-law grounds. As a result of this decision, despite the broad delegation over counterclaims under section 157(b)(2), not all counterclaims will be treated equally in bankruptcy cases.
What Happened:
Stern v. Marshall and its predecessor cases have been garnering popular attention for years due to the involvement of Anna Nicole Smith (legal name, Vicky Lynn Marshall), a former playboy model and her marriage to a billionaire – J. Howard Marshall II – almost 70 years her senior. The fight began upon the death of J. Howard Marshall, who was approximately ninety years old at the time of his marriage to Anna Nicole. A fight over the decedent’s estate began between Anna Nicole and Pierce Marshall, the son of J. Howard. Stern v. Marshall is the culmination of that legal battle.
The factual background and the course of legal proceedings are summarized as follows: This case originated in the bankruptcy court, which held that Anna Nicole had a viable counterclaim against Pierce; that the bankruptcy court could enter a final judgment; and that Anna Nicole was entitled to damages (including punitive damages) of over $400 million. Concurrently, a Texas State Probate Court trial, started by Anna Nicole, was conducted and entered a final judgment against Anna Nicole (and for Pierce). After the bankruptcy court ruling, the U.S. District Court for the Central District of California held that the counterclaim was non-core and that the bankruptcy court could not enter a final judgment on it. The case then went (i) up to the Court of Appeals, (ii) up to the Supreme Court, and (iii) back down to the Court of Appeals, where the Appeals Court held that the Texas State Probate Court was the first court to enter a final judgment because the bankruptcy court lacked authority to do so since the counterclaim was non-core. (Still with us?) This brings us to the current Supreme Court case, which was presented with the question of “whether a bankruptcy court judge who did not enjoy such tenure and salary protections had the authority under 28 U.S.C. § 157 and Article III to enter final judgment on a counterclaim...”
(** Spoiler Alert: Before we get into the actual decision, let’s frame the dispute. The Supreme Court’s decision revolves around the scope of bankruptcy court jurisdiction over different types of claims and proceedings. The debate initially grew out of the major Bankruptcy Code revision in 1978 (which, among other changes, eliminated Roman numerals – goodbye Chapter XI — after which it was determined (in Northern Pipeline, discussed below) that too much authority was delegated directly to bankruptcy courts by Congress, because bankruptcy judges are not lifetime appointees under Article III of the Constitution (as Federal Court District Judges are). Bankruptcy judges are appointed under Article I and, among other differences, do not have lifetime tenure. The shake up following Northern Pipeline resulted in the 1984 bankruptcy amendments, which were enacted to remedy the direct delegation of authority to bankruptcy judges by differentiating between “core” claims and “non-core” claims. 28 U.S.C. § 157. “Core” claims are “those that arise in a bankruptcy case or under Title 11 [(aka, the Bankruptcy Code)]” and section 157(b) provides a list of sixteen examples of “core” claims, including – as relevant to Stern v Marshall – “counterclaims by [a debtor’s] estate against persons filing claims against the estate.” On the other hand, “non-core” claims are those that are insufficiently related to the bankruptcy case. So, what does this really mean? If a matter is “core,” then a bankruptcy judge can issue a final judgment and only the legal conclusions are reviewable de novo on appeal. But, if a matter is “non-core,” then the bankruptcy judge’s findings of facts are reviewable de novo, too, making them only proposed findings of fact. Now, back to the decision….)
The Supreme Court focused its analysis, first, on 28 U.S.C. § 157(b). The Court looked to the Bankruptcy Amendments and Federal Judgment Act of 1984, specifically focusing on the fact that bankruptcy court judges are Article I judges (under the Constitution) who are appointed (i) to 14-year terms (ii) by judges in their respective court of appeals. Pursuant to 28 U.S.C. § 157(b), bankruptcy judges can enter final judgments on “core” proceedings, which includes “counterclaims by a [debtor’s estate] against persons filing claims against the estate.” 28 U.S.C. § 157(b)(2)(C). The Supreme Court held that Nicole Smith’s counterclaim, which was based in tortuous interference, fell within the jurisdictional language of that provision. (So far, so good for bankruptcy court jurisdiction….)
But, the Supreme Court went on to hold further that the bankruptcy court lacked jurisdiction to enter final judgments on non-core counterclaims, because Congress lacked Constitutional authority for the delegation to Article I judges. The Court looks to Article III for this ruling, and focuses on the previous Supreme Court case of Northern Pipeline for guidance. “In Northern Pipeline [the Supreme Court] considered whether bankruptcy judges...could constitutionally be vested with jurisdiction to decide [a] state law contract claim against an entity that was not otherwise part of the bankruptcy proceedings.” The Supreme Court in Northern Pipeline held that bankruptcy judges lacked that authority. The Northern Pipeline case revolved around the concept of “public rights.” The Supreme Court, there, held that the public rights exception “did not encompass adjudication of the state law claim at issue in that case.” However, at the time of Northern Pipeline, the concept of “core” bankruptcy proceedings did not exist; that was only created in the Bankruptcy Amendments and Federal Judgment Act of 1984. In the later case of Gianfinanciera S. A. v. Nordberg, the Supreme Court made a similar ruling holding that the public rights exception did not apply to fraudulent conveyance claims, which “more nearly resemble state law contract claims.” 492 U.S. 33 (1989).
Here, the Supreme Court emphasizes that, with regard to “core” claims, “the bankruptcy courts under the 1984 Act exercise the same powers they wielded under the Bankruptcy Act of 1978.” As such, the Supreme Court applied its ruling in Northern Pipeline (and also its subsequent ruling in Gianfinanciera), which held that the “public rights” exception does not apply to state law claims that are completely independent of federal bankruptcy law, to Anna Nicole’s counterclaim based on a state law cause of action for tortious interference. The Court compared the Gianfinanciera case, which involved a fraudulent conveyance claim, to the present counterclaim, which “is a state tort action that exists without regard to any bankruptcy proceeding.” Finally, the Supreme Court distinguished the present circumstances from two cases that allowed bankruptcy courts to adjudicate preference action claims – Katchen v. Landy, 382 U.S. 323 (1966) and Langenkamp v. Culp, 498 U.S. 42 (1990) – to address the argument that the Supreme Court should hold that a bankruptcy court could enter a final judgment on Anna Nicole’s counterclaim on the grounds that Pierce Marshall had filed a proof of claim in her bankruptcy proceedings to which it attached. The Supreme Court found those cases distinguishable (and Anna Nicole’s argument unpersuasive) because the counterclaim and underlying claim were completely unrelated; contrary to those cases where the preference actions were “asserting a right of recovery created by federal bankruptcy law,” here Anna Nicole’s claim “is in no way derived from or dependent upon bankruptcy law; it is a state law action that exists without regard to any bankruptcy proceeding.”
Therefore, the Supreme Court held that Anna Nicole Smith’s counterclaim, which (i) bears no relation to the underlying claim filed by Pierce Marshall in her bankruptcy case and (ii) is completely based in state law, cannot be ruled on by bankruptcy court judges as “core” matters. At best, despite the reference to counterclaims as “core” claims in section 157(b)(2)(C), unrelated state law counterclaims would be deemed to be “non-core”.
Why the Case is Interesting:
First, it’s a Supreme Court decision in bankruptcy. Second, this case directly impacts the jurisdictional authority of bankruptcy court judges over certain types of counterclaims that may be asserted by debtors to third party claims filed in bankruptcy cases. To the extent that a debtor’s counterclaim is unrelated to the proof of claim filed by the creditor in the bankruptcy and arises under state law, a bankruptcy court can no longer make final judgments on such claim. Instead, the counterclaim will be treated as a “non-core” claim where the bankruptcy judge will issue proposed findings of fact and conclusions of law, subject to de novo appellate review. Going forward, debtors will need to consider whether to proceed with counterclaims in the bankruptcy court or consider withdrawal of the reference over the claim to the district court.