Professor Kenneth N. Klee on the Aftermath of Stern v. Marshall: An Analysis of the Court's Ruling and a Discussion of Developing Case Law

Professor Kenneth N. Klee on the Aftermath of Stern v. Marshall: An Analysis of the Court's Ruling and a Discussion of Developing Case Law

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Prof. Kenneth N. Klee examines the developing case law in the aftermath of the Supreme Court ruling in Stern v. Marshall, in which the Court held that 28 U.S.C. § 157(b)(2)(C) is unconstitutional because it gives non-Article III judges the power to render final judgments on common law compulsory counterclaims that are not necessarily resolved in the process of allowing or disallowing the defendant's proof of claim.

Excerpt:

Stern v. Marshall was the first Supreme Court decision in almost thirty years to address the Article III limitations on bankruptcy courts' powers, and the Court issued a ruling that not only curtails the adjudicative power of bankruptcy courts but also calls into question the adjudicative authority of other non-Article III courts, such as the tribunals of magistrate judges. Specifically, the Court held that 28 U.S.C. § 157(b)(2)(C), a statute enacted by Congress in 1984, is unconstitutional because it gives non-Article III judges the power to render final judgments on common law compulsory counterclaims that are not necessarily resolved in the process of allowing or disallowing the defendant's proof of claim. The Court reached this conclusion despite the fact that the defendant had filed a proof of claim in the bankruptcy case and consented to the bankruptcy court's jurisdiction over his claim. The decision in Stern illustrates that the Court will unflinchingly defend the exclusive right of Article III judges to exercise the judicial power of the United States, even though the restrictive view expressed by the majority casts doubt on whether bankruptcy courts may exercise power over matters traditionally left to courts of equity. In the ten months since Stern was decided, the decision has already produced significant litigation over the 'scope and limits of bankruptcy courts' adjudicative authority. Many courts have found that under Stern and Granfinanciera N.A. v. Nordberg, bankruptcy courts are prohibited from finally adjudicating matters such as fraudulent transfer, preference and equitable subordination claims because these are matters of "private right" and do not need to be resolved as part of the claims resolution process. Other courts have reached the opposite conclusion, relying heavily on Stern's statements that it addressed a "narrow" question and refusing to extend Stern beyond the specific situation it addressed.

Legal Background. The backdrop for Stern and the case law developing around it is Article III, § 1 of the Constitution, which vests "[t]he judicial power of the United States" in life-tenured and salary-protected judges, who are nominated by the president and confirmed by the Senate. Non-Article III bankruptcy judges may not exercise the general judicial power of the United States and therefore may not finally resolve controversies that are not within the core Article I bankruptcy power Congress relied upon in creating the current system of bankruptcy jurisdiction. In Northern Pipeline Co. v. Marathon Pipe Line Co, a fractured plurality of the Court held that Article 1 bankruptcy courts could not constitutionally hear a state law breach of contract claim when the debtor was the plaintiff. The main question presented in Stern was whether a bankruptcy court could constitutionally enter a final judgment on an otherwise non-core tort cause of action asserted as a compulsory counterclaim to a creditor's nondischargeability complaint and proof of claim against the debtor.

Facts and Proceedings Below. The case involved two separate and conflicting lines of litigation, one in a Texas probate court and one in a Los Angeles bankruptcy court. The probate litigation began first before the death of J. Howard Marshall II ("Howard") when his wife, Vickie Lynn Marshall ("Vickie"), sued her stepson E. Pierce Marshall ("Pierce") alleging fraud and undue influence over Howard's decision to make his inter vivos trust irrevocable in order to interfere with her claimed expectancy of an inheritance from Howard. Pierce filed a nondischargeability complaint and a proof of claim for defamation against Vickie in her bankruptcy case based on her allegation that Pierce had committed this tort. Vickie then counterclaimed against Pierce in the bankruptcy court alleging tortious interference with her inheritance. The bankruptcy court disallowed Pierce's claim against Vickie's bankruptcy estate and, holding that it had core jurisdiction over the counterclaim, later entered a large judgment on Vickie's counterclaim against Pierce. While the counterclaim judgment was on appeal to the district court, Pierce won a judgment against Vickie in a jury trial before the Texas probate court. The federal district court held that the bankruptcy court erred in finding core jurisdiction over Vickie's counterclaim. Treating the bankruptcy court's decision as a report and recommendation, the district court decided the matter in favor of Vickie, refusing to give preclusive effect to the Texas judgment. Following a separate appeal and opinion by the Supreme Court regarding the scope of the "probate exception," the Ninth Circuit reversed the district court on that basis, noting that because the bankruptcy court lacked core jurisdiction over the counterclaim, the district court was bound to give the first-in-time Texas judgment preclusive effect.

Analysis of Stern. The Supreme Court granted certiorari to resolve a question left open in its first decision involving Vickie and Pierce: whether the bankruptcy court had authority to enter a final judgment on a counterclaim for tortious interference. Writing for a 5-4 majority, Chief Justice Roberts held that 28 U.S.C. § 157(b)(2)(C), in giving bankruptcy judges core jurisdiction to finally determine counterclaims not necessary to the allowance of claims, unconstitutionally delegates the judicial power of the United States to non-Article III bankruptcy judges. Justice Roberts' opinion relies heavily on the doctrine expressed in Murray's Lessee v. Hoboken Land & Improvement Co., that, with the exception of certain "public rights," Congress cannot "withdraw from judicial cognizance any matter which, from its nature, is the subject to a suit at common law, or in equity, or admiralty." See id. at 284. The counterclaim was a tort claim at common law, the adjudication of which could not be withdrawn from the Article III judiciary. Accordingly, the Court held that "[t]he Bankruptcy Court below 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." Justice Scalia wrote a concurring opinion, in which he stated how he would limit the definition of "public rights" to cases involving the government as a party. The concurrence also leaves open a question about whether bankruptcy judges may constitutionally decide objections to claims (at least claims that are not filed by the government). Justice Breyer wrote a dissenting opinion challenging the majority's constitutional interpretation.

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