United States: Analyzing The Post-'Stern' Landscape In New York

It has been more than two years since the U.S. Supreme Court's decision in Stern v. Marshall,¹ and the New York courts and litigants are still struggling with the extent of Stern's application to the bankruptcy court's jurisdiction and constitutional authority to render final orders in adversary proceedings. In fact, "Stern v. Marshall has become the mantra of every litigant who, for strategic or tactical reasons, would rather litigate somewhere other than the bankruptcy court." In re Ambac Financial Group, 457 B.R. 299, 308 (Bankr. S.D.N.Y. 2011) (J. Chapman); see also In re Extended Stay, 466 B.R. 188, 202 (S.D.N.Y. 2011) (J. Scheindlin); In re Pali Holdings, 488 B.R. 841, 848 (Bkrtcy. S.D.N.Y. 2013) (J. Gerber).

In response to litigants' attempts to remove almost every litigation from the bankruptcy court, the U.S. District Court for the Southern District of New York issued a standing order that has made it clear that Stern is not jurisdictional, but, instead, determines the bankruptcy court's constitutional authority to issue a final judgment. See Jan. 31, 2012 Amended Standing Order of Reference (discouraging litigants from moving to withdraw the reference in core proceedings and suggesting that in cases where the bankruptcy court lacks constitutional authority to issue the final decision, it shall, nevertheless, hear the proceeding and submit proposed findings of fact and conclusions of law to the district court). Other district courts have issued similar orders.

However, New York courts' views on the issue of bankruptcy court's constitutional authority are not uniform and generally fall into one of two categories. Those judges who follow the "expansive" interpretation of Stern rarely hold that the bankruptcy court has constitutional power to enter a final order in an adversary proceeding, while judges who follow the "narrow" interpretation generally hold the opposite. Not surprisingly, perhaps, a review of recent decisions in New York shows that bankruptcy courts tend to follow the "narrow" approach, while many district court judges appear to support the "expansive" approach.

This article discusses recent New York courts' interpretations of Stern in connection with adversary proceedings. Specifically, we focus on two categories of actions that arise in bankruptcy cases: actions to recover estate property directly (often called "turnover proceedings") and actions to avoid fraudulent transfers.

Turnover Proceedings

There have not been many decisions in New York concerning the bankruptcy court's authority to issue a final order in a turnover proceeding. However, Judge Robert E. Gerber's recent decision in Geron v. Peebler (In re Pali Holdings), — B.R.—, 2013 WL 1197670 (Bkrtcy. S.D.N.Y. March 25, 2013), offers a thoughtful insight on this issue. In Peebler, the court granted the trustee's motion for summary judgment seeking turnover of the proceeds of a promissory note that the defendant, David Peebler, a former employee of the Debtor, Pali Holdings (Pali), had executed in favor of Pali. The court found that Peebler's defenses to payment on the note were frivolous.

Significantly, Gerber held that he has the constitutional power to issue a final judgment against Peebler because the trustee sued for turnover of the proceeds of the note, which constituted the property of the estate, and the defendant did not raise any real or substantial defenses to the trustee's claim.

Peebler argued that a bankruptcy judge lacks the constitutional power to issue a final judgment in this adversary proceeding. Gerber rejected Peebler's arguments, finding that "a turnover proceeding like this one is a paradigmatic exercise of the Court's in rem jurisdiction, very different from the scenarios in Marathon and Stern."

As an initial matter, Gerber noted that the reported post-Stern decisions have overwhelmingly held that bankruptcy judges can constitutionally enter final judgments in turnover actions.² Next, the judge held that "a turnover action's essence is in bringing the estate's property into its custody—or in the promissory note and account receivable collection actions for which turnover may also be invoked as a statutory matter, in converting a note or account receivable that is already property of the estate into cash" (emphasis added).

Since Peebler did not offer any "serious defenses" to the estate's §542 turnover rights, a bankruptcy judge can exercise the bankruptcy court's in rem jurisdiction to issue a final judgment for the turnover of the estate's property, or to monetize it.³

Notably, Gerber cautioned that the turnover power may not be invoked "when it is used as a Trojan Horse for bringing garden variety contract claims; when the property in question is not already property of the estate; or when the turnover statute is used to recover assets with disputed title when the estate's claim of ownership is legitimately debatable."

In Peebler, the defendant, who admitted to signing the note, did not have any significant defenses to the trustee's claim. The result might have been different if the defendant had presented sufficient evidence to dispute the turnover claim (for example, by presenting evidence questioning the authenticity of his signature on the note, or supporting alleged duress and unconscionability defenses). See also In re Fairfield Sentry, 458 B.R. 665, 683 (S.D.N.Y. 2011) (J. Scheindlin) (noting that an action for turnover of property would be core and one in which a bankruptcy judge can enter a final judgment when the purpose of the action was to collect a matured debt, as contrasted to an action where the property to be recovered was the subject of a significant dispute); see also In re Fine Diamonds, Case No. 09-10492, Adversary Proceeding No. 09-01033, 2013 WL 5614231, 1 (Bkrtcy. S.D.N.Y. Oct. 11, 2013) (J. Gerber) (once again confirming that a bankruptcy court has constitutional authority to enter a final judgment in a turnover proceeding). See also McClelland v. Grubbs & Ellis Valuation and Advisory Grp. (In re McClelland), 460 B.R. 397 (Bankr. S.D.N.Y. 2011) (J. Morris) (finding that Stern has narrow application and determining that an action regarding professional negligence that allegedly occurred in connection with the bankruptcy case was a core proceeding in which a bankruptcy judge may issue final orders because the lawsuit concerned administration of the estate and implicated work done by a court-appointed professional).

Fraudulent Transfers

The decisions on fraudulent transfers are divided along different analytical lines. As noted by Judge Robert D. Drain, "[r] easonable people may differ over whether Stern's prohibition on the bankruptcy court's issuance of a final judgment extends to fraudulent transfer claims." In re Refco, 461 B.R. 181, 186 (Bkrtcy. S.D.N.Y. 2011). The courts seem to agree that the defendant's filing of the proof of claim provides the bankruptcy court with constitutional authority to rule on the fraudulent transfer action. See, e.g., In re Quebecor World (USA), 491 B.R. 379, 384, 2013 WL 1741946, 2 (Bkrtcy. S.D.N.Y. 2013) (J. Lane).

The courts differ, however, over the issue of the bankruptcy court's authority in cases where the defendant did not file a proof of claim. The majority of courts in New York (in particular, the district courts) follow the "expansive" application of Stern and hold that a bankruptcy court does not have constitutional authority to issue a final order on a fraudulent transfer claim. See Kramer v. Mahia, No. 12 MC 794, 2013 WL 1629254 (E.D.N.Y. April 15, 2013) (J. Irizarry); Nisselson v. Salim, No. 12 civ 92, 2013 WL 1245548 (S.D.N.Y. March 25, 2013) (J. Gardephe); Sec. Investor Protection v. Bernard L. Madoff Inv. Sec., 490 B.R. 46, 52 (S.D.N.Y. 2013) (J. Rakoff); Weisfelner v. Blavatnik (In re  Lyondell Chem.), 467 B.R. 712 (S.D.N.Y. 2012) (J. Cote); In re Madison Bentley Associates, 474 B.R. 430, 436 (S.D.N.Y. 2012) (J. Scheindlin).

But see Fox v. Picard (In re Madoff), Nos. 10 Civ. 4652, 10 Civ. 7101, 10 Civ. 7219, 11 Civ. 1298, 11 Civ. 1328, 2012 WL 990829, at *12 n.5 (S.D.N.Y. March 26, 2012) (J. Koeltl) (declining, in a footnote, to extend Stern to fraudulent conveyance claims); In re Fine Diamonds, 2013 WL 5614231, 1 (Bkrtcy. S.D.N.Y. 2013) (J. Gerber); In re Perry H.  Koplik & Sons, 476 B.R. 746, 755 (Bkrtcy. S.D.N.Y. 2012) (J. Gerber) (the fraudulent transfer claims asserted here are within this court's power constitutionally to enter final judgment); In re Refco, 461 B.R. 181 (Bkrtcy. S.D.N.Y. 2011). (J. Drain).

Those who believe that the bankruptcy court does not have constitutional authority to issue the final order on a fraudulent conveyance claim rely on the fact that in Stern, the Supreme Court set forth only three instances where a bankruptcy court may render a final decision. According to Stern, the bankruptcy court has authority to render a final decision if (1) the claim involves a public right; (2) the process of adjudicating the creditor's proof of claim would resolve a counterclaim; or (3) the parties consent to final adjudication by the bankruptcy court. See, e.g., Nisselson, 2013 WL 1245548, *4; In re Lyondell Chem., 467 B.R. 712, 720 (S.D.N.Y. 2012) (applying these three considerations in deciding motion to withdraw bankruptcy reference).

In another older case, the Supreme Court already found that "a bankruptcy trustee's right to recover a fraudulent [or preferential] conveyance ... [is] more accurately characterized as a private rather than a public right." Granfinanciera,  S.A. v. Nordberg, 492 U.S. 33, 55, 109 S. Ct. 2782, 106 L.Ed.2d 26 (1989).

Based on this language from the Supreme Court's decisions in Stern and Granfinanciera, there is an "emerging consensus" in New York that the bankruptcy court may not ordinarily enter a final judgment on avoidance claims. Nisselson, 2013 WL 1245548, *4; see also Weisfelner, 467 B.R. at 720 ("Under both Stern and Granfinanciera...it is axiomatic that a fraudulent conveyance claim against a person who has not submitted a claim against a bankruptcy estate, brought solely to augment the bankruptcy estate, is a matter of private right."); Kirschner v. Agoglia (In re  Refco), No. 11 Civ. 8250, 2012 WL 1622496, at *3 (S.D.N.Y. May 9, 2012) (J. Rakoff) ("To now conclude that the very claim presented in Granfinanciera—a fraudulent conveyance claim—is a 'public rights' claim would be totally at odds with the Stern Court's analogy to Granfinanciera"); In re Coudert Bros., App. Case No. 11-2785, Adv. Pro. No. 08-1472, 2011 WL 5593147, at *8-9 (Sept. 23, 2011) (J. McMahon).

Those courts that disagree with the majority suggest that, as in the case of a turnover proceeding, "the pursuit of avoidance claims has been a core aspect of the administration of bankrupt estates since the 18th century, tied to, if not solely based on, the bankruptcy court's 'principally in rem jurisdiction.'" In re Refco, 461 B.R. at 187. Moreover, unlike the state law claim in Stern, the fraudulent transfer claim is based on "a federal statutory scheme." See id. In fact, several sections of the Bankruptcy Code "govern the trustee or debtor-in-possession's unique role in investigating, funding, commencing, litigating and settling fraudulent transfer claims for the benefit of the estate, other parties' limited standing to do so in the trustee's place, and, ultimately, the power of the bankruptcy judge to manage the process in the context of the overall bankruptcy case." Id.

Conclusion

Although recent decisions shed some light on New York courts' interpretation of Stern v. Marshall, there remains a significant split among judges in New York on whether the bankruptcy court may issue a final order in various adversary proceedings. As a result, until further clarification from the Supreme Court, issues that were traditionally decided by the bankruptcy court might have to be resubmitted to the district court for final adjudication.

In fact, the Supreme Court may shed light on these issues soon. The U.S. Supreme Court recently granted certiorari in Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency), 702 F.3d 553 (9th Cir. 2012). In Bellingham, the Ninth Circuit held that although fraudulent transfer claims "against non-claimants (i.e., defendants who have not filed proofs of claim) generally cannot be adjudicated by non-Article III judges, the right to an Article III tribunal is a 'personal' right, and is thus subject to waiver."4

Footnotes:

1.—U.S.—, 131 S. Ct. 2594, 180 L.Ed.2d 475 (2011).

2.The court cited various decisions with similar holdings from other jurisdictions, including Badami v. Sears (In re AFY), 461 B.R. 541 (8th Cir. BAP 2012) (concluding that bankruptcy judge could issue a final judgment in a turnover proceeding; noting that "the Supreme Court itself has cautioned that its holding is a narrow one, affecting only ? one small part of the bankruptcy judges' authority. Unless and until the Supreme Court visits other provisions of Section 157 (b)(2), we take the Supreme Court at its word and hold that the balance of the authority granted to bankruptcy judges by Congress in 28 U.S.C. §157(b)(2) is constitutional"); In re Crescent Resources, 457 B.R. 506, 510 & n.2 (Bankr. W.D.Tex. 2011) (concluding that bankruptcy court could issue a final judgment in a turnover matter, explaining that Stern dealt with issues different than those in the turnover matter before him, and likewise concluding that Stern should be applied narrowly); In re McCrory, 2011 Bankr.LEXIS 3403, at *2, 2011 WL 4005455, at *1 (Bankr. N.D. Ohio Sept. 8, 2011); In re Hernandez, 468 B.R. 396, 401 n.4 (Bankr. S.D. Cal. 2012); Rentas v. Claudio (In re Garcia ), 471 B.R. 324, 330 (Bankr. D.P.R. 2012); Shaia v. Taylor (In re Connelly), 476 B.R. 223, 231-34 (Bankr. E.D. Va. 2012); Burns v. Dennis (In re Southeastern Materials), 467 B.R. 337, 357 (Bankr. M.D.N.C. 2012) (Waldrep, J.) (Southeastern Materials); In re Miller, 2011 WL 3741846, at *1 (Bankr. N.D. Ohio Aug. 24, 2011).

3."Just as bankruptcy courts under the 1898 Act could exercise summary jurisdiction over turnover claims when the defenses to such claims were not 'real and substantial,' they can do the equivalent of that now. Whatever constitutional limits might exist with respect to bringing new property into the estate (such as in actions at common law on contracts), those limits cannot be said to exist with respect to recovering property—or on property—that is already there."

4.For further discussion on the subject, see Kenneth N. Klee on the Supreme Court's Grant of Certiorari in Exec. Benefits Ins. Agency v. Arkison (In re Bellingham Ins. Agency), 702 F.3d 553 (9th Cir. 2012), http://www.lexisnexis.com/legalnewsroom/bankruptcy/b/bankruptcy-law-blog/archive/2013/08/14/professor-kenneth-n-klee-on-the-supreme-court-39-s-grant-of-certiorari-in-exec-benefits-ins-agency-v-arkison-in-re-bellingham-ins-agency-702-f-3d-553-9th-cir-2012.aspx.

Reprinted with permission from the December 12, 2013 edition of the New York Law Journal© 2013 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. ALMReprints.com - 877-257-3382 - reprints@alm.com.

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