Supreme Court Dodges Consent Issue in Bellingham But Signals No New Challenges to Bankruptcy Court Authority

 In the follow-up to Stern v. Marshall, the Supreme Court concluded that it didn’t need to answer the primary questions addressed to it, leaving open (on the surface at least) the issue of whether parties can consent to final adjudication by a bankruptcy court in situations where the court could not otherwise issue a final decision. The Court also assumed but did not decide the question of whether a fraudulent conveyance action would violate Stern. In fact, the only issue the Court did decide was that bankruptcy courts may issue reports and recommendations in core proceedings where they lack authority to make a final ruling. While the decision is not as expansive as many practitioners would have liked, it doesn’t do any violence to the bankruptcy system and has some helpful subtext. The case is Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency, Inc.), No. 12-1200 (June 9, 2014). You can find the opinion here [an enhanced version of this opinion is available to lexis.com subscribers].

What Happened

Nicholas Palaveda and his wife owned Bellingham Insurance Agency, Inc. (BIA). Palaveda used Bellingham’s assets to set up a new business, Executive Benefits Insurance Agency, Inc. (EBIA). When BIA filed bankruptcy, its trustee, Arkison, sued EBIA to recover the assets as a fraudulent transfer. EBIA did not assert its right to a hearing before an Article III judge and either consented to adjudication by the Bankruptcy Court or waived its right to district court review. Arkison filed a motion for summary judgment which was granted. The District Court affirmed the Bankruptcy Court. Because this was a review of a summary judgment, the District Court’s review was necessarily on a de novo basis.

The Ninth Circuit, after inviting amicus briefs, affirmed. It found that while a fraudulent conveyance action was not within the Bankruptcy Court’s authority to enter a final decision, that EBIA had consented to the Bankruptcy Court’s authority and could not question it on appeal. Thus, the Ninth Circuit answered two important questions: 1) did the Bankruptcy Court have final authority to rule on a fraudulent conveyance (no); and 2) could the parties consent to the Bankruptcy Court’s ability to enter a final ruling (yes).

The Supreme Court’s Ruling

Unlike the contentious ruling in SternBellingham was a 9-0 decision comprising a scant 13 pages of text. The Court avoided ruling on either of the main conclusions of the Ninth Circuit, assuming without deciding that fraudulent conveyance claims violated Stern and finding that it need not reach the consent issue. As will be discussed below, the opinion is more significant for what it implies than what it decided.

The court began with a history of bankruptcy jurisdiction, taking practitioners through the familiar history of summary vs. plenary jurisdiction under the Bankruptcy Act, the expansive but unconstitutional jurisdiction granted under the Bankruptcy Reform Act of 1979 and the core vs. non-core dichotomy enacted by the Bankruptcy Amendments and Federal Judgeship Act of 1984.

The core vs. non-core distinction attempted to remedy the finding of unconstitutionality contained in Northern Pipeline Construction Co. v. Marathon Pipeline Co., 458 U.S. 50 (1982) [enhanced version]. According to Justice Thomas,

The 1984 Act largely restored the bifurcated jurisdictional scheme that existed prior to the 1978 Act. The 1984 Act implements that bifurcated scheme by dividing all matters that may be referred to the bankruptcy court into two categories: “core” and “non-core” proceedings.

Opinion, p. 6. In a footnote, Justice Thomas noted that the “core” designation tracked language used by the plurality opinion in Northern Pipeline.

Justice Thomas summarized the current working of the bankruptcy system as follows:

Put simply:  If a matter is core, the statute empowers the bankruptcy judge to enter final judgment on the claim, subject to appellate review by the district court. If a matter is non-core, and the parties have not consented to final adjudication by the bankruptcy court, the bankruptcy judge must propose findings of fact and conclusions of law. Then the district court must review the proceeding de novoand enter final judgment. (emphasis added).

Opinion, p. 7.

In several brief passages, the Court addressed what the Stern decision did and did not address. According to Justice Thomas, Stern “considered a constitutional challenge to the statutory designation of a particular claim as ‘core.’” The answer was that “some claims labeled by Congress as ‘core’ may not be adjudicated by a bankruptcy court in the manner designated by §157(b).” Left unanswered in Stern was “how the bankruptcy court should proceed in those circumstances.” Id.

This led up to the main question actually addressed by Bellingham(as opposed to the ones it granted cert on):  whether there is a gap in the statutory scheme of core vs. non-core. BAFJA allowed entry of final orders on core matters and proposed findings in non-core. What to do with core proceedings in which bankruptcy courts cannot constitutionally enter a final judgment?   Are these matters left in limbo, incapable of being resolved?   The sensible answer from the Supremes is no. BAFJA, like most statutes, contains a severability clause. The Court concluded that any matter upon which the bankruptcy courts cannot properly enter a final judgment should simply be treated as non-core.

The plain text of this severability provision closes the so-called “gap” created by Stern claims. When a court identifies a claim as a Stern claim, it has necessarily held “invalid” the application of §157(b)—i.e., the “core” label and its attendant procedures—to the litigant’s claim. (citation omitted). In that circumstance, the statute instructs that “th[e] remainder of the Act . . . is not affected thereby. (citation omitted). That remainder includes §157(c), which governs non-core proceedings. With the “core” category no longer available for the Stern claim at issue, we look to §157(c)(1) to determine whether the claim may be adjudicated as a non-core claim—specifically, whether it is “not a core proceeding” but is “otherwise related to a case under Title 11.” If the claim satisfies the criteria of §157(c)(1), the bankruptcy court simply treats the claims as non-core:  the bankruptcy court should hear the proceeding and submit proposed findings of fact and conclusions of law to the district court for de novo review and entry of judgment.

Opinion, pp. 9-10.

In the particular case, the bankruptcy court should have submitted proposed findings and conclusions to the district court which would then conduct a de novo review and enter judgment. As Justice Thomas noted, “(a)lthough this case did not proceed in precisely that fashion, we affirm nevertheless.” Opinion, p. 12. When a court grants summary judgment, its order is reviewed as a matter of law, which is de novo review. Thus, the district court did conduct ade novo review and did enter a judgment affirming the bankruptcy court. As a result, the substance of the law was satisfied.

In light of the procedural posture of this case, however, we need not decide whether EBIA’s contentions are correct on either score. At bottom, EBIA argues that it was entitled to have an Article III court review de novo and enter final judgment on the fraudulent conveyance claims asserted by the trustee. In effect, EBIA received exactly that.

Opinion, p. 12. Thus, the opinions of the lower courts were affirmed and Mr. Palaveda’s scheme remained unraveled notwithstanding the detour to the Supreme Court.

So What Did the Court Decide?

Prudentialism is the school of supreme court jurisprudence that says that the court should decide as little as possible to conserve the court’s power and prestige. It can also be described as passive-aggressive judging. This was certainly an example of prudential review. No doubt it is frustrating to the litigants to go all the way to the Supreme Court without receiving answers on the main questions that they briefed. However, the Court’s non-answers to the larger questions may speak volumes.

First, the court preserved the core vs. non-core system that we have been operating under since 1984. In the wake of Stern v. Marshall [enhanced version], many commentators had declared this structure to be a dead letter, since it was unconstitutionally overbroad. Not so, says the high court. It simply needs to be fine-tuned by our friend severability. This should properly be viewed as a signal, although oblique, that the Supreme Court does not wish to throw out the bankruptcy system as some had feared.

Second, while the court did not expressly decide the consent issue, it did so indirectly. By saying that core but unconstitutional matters should be treated as non-core under the statutory procedures of 28 U.S.C. §157(c), the court referred to a statutory provision which included consent. Indeed, Justice Thomas’s discussion of the statutory scheme expressly stated that proposed findings and conclusions are only necessary where the parties have not consented. If consent was not constitutionally viable, the Court would have been expected to at least drop a footnote stating that they were not opining on that portion of the law. When Justice Thomas said that courts should follow §157(c), which includes consent, he was implicitly upholding consent.

Finally, while the Court did not rule on whether fraudulent conveyance claims failed the Stern test, it noted that no party had disputed this conclusion. Thus, while it is not a direct holding, it is a clear signal.

In my opinion, Bellingham is a signal from a unanimous Court that the BAFJA core vs. non-core system still works, although it needed to be tweaked. The new “core” proceedings will look somewhat like the old summary jurisdiction under the Bankruptcy Act. Proceedings intended to augment the estate which are not necessary to determination of a claim, will now be considered non-core matters regardless of how Congress classified them in 1984.

However, I do see one big issue that remains to be decided. What happens if a Bankruptcy Court enters a final judgment on a matter that is constitutionally non-core and no party seeks de novo review from the District Court?   Is that an invalid judgment that can be collaterally attacked or does the failure to seek de novo review constitute consent?    Must there be actual de novo review or merely the opportunity for de novo review?  There are certainly other questions lingering out there as well. This means that while the boat has not been capsized (at least for today), we have not felt the last ripples from Stern v. Marshall.

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