Stern v. Marshall - A Must-Read for Every Bankruptcy Litigator

July 18, 2011

Content originally posted on MGLAW.net

On June 23, 2011, the United States Supreme Court issued its opinion in Stern v. Marshall, a 5-4 decision that held that bankruptcy courts do not have jurisdiction to issue final judgment of certain claims that have been constitutionally reserved for state or federal district courts. Now that a month has elapsed since the decision, bankruptcy academics and practitioners are still speculating about what the fallout will be. The blogosphere has been all over the map, referring to the decision as everything from a "bombshell" to a narrow ruling that will have little practical consequences. The only point upon which reviewers seem to agree is that bankruptcy courts will likely have to address the opinion in the very near future. This article will discuss the facts of the case, highlight the open questions that are currently being debated, and weigh-in on the future possible consequences of Stern v. Marshall.

I. Case Digest

Stern v. Marshall has a tortured factual and procedural history that does not need to be fully discussed. But, the essential facts for the purposes of this article are pretty straightforward. Vickie Lynn Marshall (more popularly known as Anna Nicole Smith) and Pierce Marshall wanted a piece of J. Howard Marshall's (husband of Anna Nicole; father of Pierce) fortune after his death. After J. Howard died, Anna Nicole filed for bankruptcy. Pierce filed a nondischargeability complaint and proof of claim in her bankruptcy, both based on defamation. Anna Nicole denied the allegations and filed a counterclaim for tortious interference arising out of Pierce allegedly tortiously inducing J. Howard to write Anna Nicole out of his will. The bankruptcy court granted judgment in favor of Anna Nicole on Pierce's claim and later awarded her over $425 million in damages on her counterclaim, which the bankruptcy court treated as a "core proceeding" under 28 U.S.C. § 157(b)(2)(C). Pierce appealed, despite consenting to the bankruptcy court hearing the dispute. A volley of legal positions were hurled back and forth by Anna Nicole Smith and Pierce Marshall. Here is how the Supreme Court ultimately "scored" the match.

a. Issue - Whether § 157(b)(2)(C) Permitted the Bankruptcy Court to Enter a Final Judgment on Anna Nicole's Counterclaim for Tortious Interference

After the trial, Pierce argued the bankruptcy court did not have the ability to enter a final judgment on Anna Nicole's counterclaim, arguing it was not a core proceeding and, therefore, the bankruptcy court could only submit findings of fact and conclusions of law for approval by the district court. The Supreme Court disagreed based on the plain language of § 157(b)(2)(C), which specifies that "counterclaims by the estate against persons filing claims against the estate" are indeed core proceedings. But, Pierce's second argument contended that even if a proceeding is "core," a bankruptcy court does not have the authority to enter a final judgment unless the proceeding "arises in" or "arises under" Title 11. The Supreme Court again disagreed and believed that Congress, in cataloging sixteen types of core proceedings, intended that all sixteen types of core proceedings arise in or arise under Title 11. Therefore, as a matter of statutory construction, the bankruptcy court could enter a final judgment pursuant to § 157(b)(2)(C). Advantage Anna Nicole.

b. Issue - Whether the Bankruptcy Court had Jurisdiction to Enter a Final Judgment on Pierce's Claim for Defamation and Anna Nicole's Counterclaim for Tortious Interferene

Pierce next argued that pursuant to § 157 of the Bankruptcy Code, the bankruptcy court lacked jurisdiction to enter final judgment on his defamation action (and therefore Anna Nicole's counterclaim as well). The Court disagreed. It determined that § 157 was not jurisdictional, and regardless Pierce waived any statutory limitation to the bankruptcy court's jurisdiction by consenting to the bankruptcy court's jurisdiction (i.e., by filing a proof of claim and through the adversary proceeding). Advantage Anna Nicole.

c. Issue - Whether Article III of the Constitution Permitted the Bankruptcy Court to Enter a Final Judgment on Pierce's Claim for Defamation

The Court next had to determine if it could reconcile the bankruptcy court's ability to render a final judgment on a common law cause of action under state law with Article III, §1, which mandates that judicial power be vested in courts established by Congress and comprised of judges who shall not have diminished salary during tenure. It is not disputed that the bankruptcy court entered final judgment on a common law action, and further that bankruptcy judges are not tenured without the possibility of diminished salary. The Court then analyzed Anna Nicole's basis for claiming the bankruptcy court's final judgment was constitutional.

1. Does the "public rights" exception apply? To defend the bankruptcy court's ruling, Anna Nicole argued that her counterclaim should fall under a "public rights" exception to the enforcement of Article III. The public rights exception dates back to 1856 and allows Congress to present certain justiciable matters to non-Article III courts. Although the doctrine has undergone various formulations, the Court, relying on Northern Pipeline, 458 U.S. 50 (1982), and Granfinanciera, 492 U.S. 33 (1989), determined that the exception must be (and has always been) limited to cases in which the claim at issue derives from a federal regulatory scheme or requires an expert government agency to resolve the claim. Because Anna Nicole's counterclaim was a state law claim for tortious interference, there was no basis for invoking it.

2. Does the fact that Pierce filed a proof of claim matter? Anna Nicole then argued the obvious - Pierce filed a proof of claim and therefore submitted to the bankruptcy court's jurisdiction. The Court rejected this argument as well for purposes of Anna Nicole's counterclaim, making sure to clarify that Pierce's proof of claim for defamation should not make a difference when analyzing Anna Nicole's claim for tortious interference. "Pierce's claim for defamation in no way affects the nature of [Anna Nicole's] counterclaim for tortious interference as one at common law that simply attempts to augment the bankruptcy estate - the very type of claim that we held in Northern Pipeline and Granfinanciera must be decided by an Article III court."

3. Are bankruptcy judges "adjuncts" of district court judges? Finally, Anna Nicole argued that bankruptcy judges are "adjuncts" of the district courts. The Court pointed out that bankruptcy judges resolve "all matters of fact and law in whatever domains of the law to which the parties' counterclaims might lead." Therefore, the bankruptcy court exercises the "essential attributes" of judicial power and cannot be considered "adjunct" as that term has been used to defend against Article III challenges.

With the failure of these challenges and the Court not persuaded (or concerned) that ruling the bankruptcy court's decision unconstitutional will create significant delays and impose additional costs on the process, the Court concluded that the bankruptcy court "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." Advantage and match to Pierce.

II. Open Questions & Future Impact on Practice

In the wake of the Court's decision, it remains unclear whether Stern v. Marshall will have a major impact on bankruptcy practice. No statistics have been compiled, and only informal discourse and banter can be used to guess what will follow. Despite the uncertainty, there appear to be several questions that immediately come to mind:

1. How will bankruptcy court judges apply Stern v. Marshall? It is too early to know whether bankruptcy court judges will embrace Justice Roberts' attempts to limit application of the case, reference to the opinion as "narrow," and clarification that the opinion only addresses "one isolated respect" of Congress' behavior. It seems unlikely that bankruptcy court judges will use the decision to push matters off their dockets; such a motivation would be inconsistent with the goals of bankruptcy.

2. How will practitioners react to Stern v. Marshall? The knee-jerk reaction is to assume that the opinion is a game-changer in the world of bankruptcy litigation. Some fear state law claims will start being raised more in counterclaims to adversary proceedings. Others are concerned that adversary proceedings will get a lot more expensive and time consuming whenever non-bankruptcy claims are involved. Despite some calling the decision a "bombshell," it seems most likely that the opinion will have little impact on the bankruptcy process. First, the reality is that most claims are resolved during the process of ruling on a creditor's proof of claim. Nothing will be left to litigate after resolving the claim, so Stern v. Marshall will not be an issue in these cases. Second, and more importantly, parties will continue to use the bankruptcy courts to litigate their claims. The district court will now only be involved to review the bankruptcy judges' findings and enter final judgment.

3. What is the effect on § 157(b)(2)(H) fraudulent conveyance claims? It will be interesting to see how debtors and defendants handle future fraudulent conveyance claims that arise under state law. It seems very possible that debtors and creditors alike will not even request a bankruptcy judge to enter final judgment on these matters. It will also be interesting to hear arguments in relation to § 548 fraudulent transfer claims that arise solely from a debtor receiving less than reasonably equivalent value during a period of insolvency (and not when any bad intent is alleged against a defendant).

4. What happens to previous cases decided by bankruptcy judges that violated Stern v. Marshall? Every party (more specifically, every counsel to every party) should consider what, if anything, to do if Stern v. Marshall could be retroactively applied to invalidate a final judgment. Can it be set aside under Federal Rules of Bankruptcy Procedure 9023 or 9024? The analysis to this question is beyond the scope of this article, but it is likely to be raised.

Time will soon reveal the answers to these questions. In the meantime, every bankruptcy litigator must know and appreciate the facts of Stern v. Marshall. Even if it does not ultimately result in significant changes to the process, the case will surely be a topic of discussion for years to come during certain adversary proceedings.