An important new decision out of the U.S. Court of Appeals for the Ninth Circuit not only adds to the growing body of case law interpreting and applying the Supreme Court's controversial Stern v. Marshall decision, but will have bankruptcy practitioners considering even more carefully whether, when and how to challenge a bankruptcy court's jurisdiction to enter a final order in an avoidance action.
The Ninth Circuit's opinion in Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency), No. 11-35162, 2012 U.S. App. LEXIS 24873 (Dec. 4, 2012), offers a cautionary tale of the consequences litigants can suffer by not asserting timely jurisdictional challenges in the bankruptcy court or delaying such challenges until dispositive motions are decided. The court found that although the bankruptcy court did not have the constitutional authority to enter a final judgment in a fraudulent conveyance action against a nonclaimant to the bankruptcy estate, the defendant impliedly consented to the bankruptcy judge's adjudication of the claim by failing to object until the case reached the circuit court appeal, despite knowing it had grounds to do so. The Bellingham decision makes clear that, despite whatever confusion reigns post-Stern regarding bankruptcy court jurisdiction, defendants who so desire are well-served to challenge jurisdiction at the earliest possible stage or risk being found to have consented to the bankruptcy court's entry of final judgment.
In Bellingham, the bankruptcy trustee filed a complaint against two affiliates of the debtor to recover commissions deposited into the affiliates' bank account. The complaint included federal and state law fraudulent transfer claims. The bankruptcy court entered summary judgment in favor of the trustee, concluding in part that the deposits were fraudulent conveyances. The district court affirmed, holding that the commissions were fraudulent transfers under both Section 548 of the Bankruptcy Code and under Washington's state fraudulent transfer statute. One of the defendants appealed, and prior to oral argument, submitted a motion to vacate the bankruptcy court judgment for lack of subject-matter jurisdiction, relying on Stern, 131 S. Ct. (2011), to object for the first time that the bankruptcy court was constitutionally proscribed from entering final judgment on the trustee's claims.
The Bellingham court first tackled the application of Stern to the case before it. As bankruptcy practitioners are well aware, the Stern decision has created considerable confusion among the lower courts and bankruptcy litigants with respect to the ability of a bankruptcy court to render final judgment on what had been considered "meat and potatoes" bankruptcy avoidance actions, such as fraudulent transfer claims. Stern found that a bankruptcy judge, as a non-Article III judge under the U.S. Constitution, could not enter final judgment on a state-law claim for tortious interference with a gift expectancy, asserted as a compulsory counterclaim to a proof of claim filed in the bankruptcy case, because the state-law claim did not under its prior precedent constitute a "public right" subject to adjudication by non-Article III judges. In so doing, the Stern court looked to its decision in Granfinanciera S.A. v. Nordberg, 492 U.S. 33 (1989), which held that fraudulent conveyance actions are not a matter of public right because they are quintessentially suits at common law that more nearly resemble state-law contract claims brought to augment the bankruptcy estate than creditors' claims to a pro rata share of the bankruptcy estate, and therefore a noncreditor defendant retains a Seventh Amendment right to a jury trial on the fraudulent conveyance claims. The Stern court found that the state-law counterclaim before it, like the fraudulent conveyance claim in Granfinanciera, did not represent a public right.
The Ninth Circuit concluded that Granfinanciera and Stern "together point ineluctably to the conclusion that fraudulent conveyance claims, because they do not fall within the public rights exception, cannot be adjudicated by non-Article III judges," and bankruptcy courts do not have the authority to enter final judgments asserted against noncreditors to the bankruptcy estate. The court reasoned that Stern fully equated bankruptcy litigants' Seventh Amendment right to a jury trial in bankruptcy proceedings with their right to proceed before an Article III judge, and therefore unless a legal cause of action involves public rights parties have a right to have those causes of action determined by an Article III tribunal. In the case before it, the debtor's affiliate was a noncreditor to the bankruptcy estate and hence was not subject to the bankruptcy court's jurisdiction.
The court then addressed whether bankruptcy judges could constitutionally hear such claims and prepare recommendations for de novo review by the federal district courts. The court noted that Section 157, Title 28 of the U.S. Code gives bankruptcy judges the authority to hear and determine "core proceedings," but only to submit proposed findings of fact and conclusions of law to the district court in non-core proceedings. Among the statutorily enumerated core proceedings are fraudulent conveyances proceedings. The court recognized in its ruling that bankruptcy courts cannot constitutionally decide fraudulent transfer claims against noncreditors created a "gap" in this framework, because there is no statutory authorization for bankruptcy courts to submit proposed findings of fact and conclusions of law in what have been deemed core proceedings. The court resolved this gap by concluding that the power to "hear and determine" a proceeding "surely encompasses" the more modest power to hear the proceeding and submit proposed findings of fact and conclusions of law to the district court. According to the Ninth Circuit, only the power to enter final judgment is abrogated.
The court then turned to whether the defendant had, through litigation tactics, waived its Article III right. The court reasoned that, under Supreme Court jurisprudence, Article III serves to protect primarily personal, rather than structural, interests, and therefore its guarantees are subject to waiver. The Ninth Circuit observed that because Section 157 expressly provides that bankruptcy courts can enter final judgments in non-core proceedings with the consent of all parties to the proceeding, the question became whether the defendant's actions represented implied consent to jurisdiction.
The defendant had initially demanded a jury trial under Granfinanciera, which the district court treated as a motion to withdraw the reference. The defendant, however, elected not to pursue a hearing, and instead asked the district court to stay consideration of the motion to allow the bankruptcy court to first adjudicate the trustee's motion for summary judgment. As the Ninth Circuit put it, the defendant "did not simply fail to object to the bankruptcy court's authority to enter final judgment in the fraudulent conveyance action; it affirmatively assented to suspend its demand for a jury trial in district court to give the bankruptcy judge an opportunity to adjudicate the claim." After the bankruptcy court granted the trustee summary judgment, the defendant abandoned the motion to withdraw the reference, and instead appealed the bankruptcy court's judgment. The defendant did not argue on appeal that the bankruptcy court lacked authority to issue a final judgment, but instead raised its constitutional objection after briefing in the Ninth Circuit appeal was complete. The Ninth Circuit concluded that because the defendant "waited so long to object, and in light of its litigation tactics, we have little difficulty concluding that [the defendant] impliedly consented to the bankruptcy court's jurisdiction."
The court reasoned that the text of Section 157 allowed for implied consent. Here, where the defendant knew of its right to seek withdrawal of the reference but instead litigated before the bankruptcy court, consent was established. The Ninth Circuit also reasoned that the defendant had reason to be alert to the possible jurisdictional problem; although Stern was not issued until the defendant's appeal was pending, the circuit decision in Stern had been published before the defendant requested a stay of its motion to withdraw the reference, and although it reached the opposite conclusion from Stern, together with Granfinaciera, it should have been sufficient to alert the defendant to the possible jurisdictional problem. The Ninth Circuit concluded that the defendant fully litigated the fraudulent conveyance action before the bankruptcy court and the district court, "without so much of a peep about Article III. ... The consequences of a litigant sandbagging the court — remaining silent about his objection and belatedly raising the error only if the case does not conclude in his favor — can be severe."
The Ninth Circuit went on to affirm the district court and bankruptcy court's grant of summary judgment on the trustee's state law constructive fraud claims. The Bellingham decision therefore represents a stark lesson for practitioners of the consequences that can befall litigants seeking to take advantage of procedural tactics, particularly with respect to jurisdictional challenges in the post-Stern bankruptcy world. While the impact of Stern may still be shaking out, it is clear that not only must the jurisdictional challenge be raised, but it must also be pursued at the earliest possible stage, lest your client suffer a fate similar to the Bellingham defendant.
Previously published from the December 21, 2012 issue of The Legal Intelligencer.
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