In a recent opinion, the Sixth Circuit has provided clarification of Stern v. Marshall's1 holding by analyzing Article III “judicial power,” the pubic rights doctrine, and the bankruptcy court's authority.
In Waldman, the Western District of Kentucky Bankruptcy Court entered a judgment against the principal creditor after finding that the creditor had defrauded the debtor and had acquired nearly all of the debtor’s assets by means of fraud. The Bankruptcy Court entered a judgment discharging the debts the debtor owed the creditor and awarded the debtor a judgment of more than $3 million in compensatory and punitive damages. The creditor appealed the Bankruptcy Court’s entry of a final judgment based upon three challenges: (1) the debtor’s state law fraud claims are beyond the jurisdiction of the federal court; (2) the judgment entered was beyond the statutory authority of the bankruptcy court; and (3) the judgment was beyond the bankruptcy court’s power pursuant to Article III of the Constitution.
The Sixth Circuit first reviewed the creditor’s argument that the debtor’s claims are beyond the jurisdiction of the federal court. Citing Northern Pipeline,2 the Court rejected the argument by noting that the United States Supreme Court has previously held that a state law claim may be adjudicated in federal court based upon the claim’s relationship to the bankruptcy petition. Therefore, the matter need not "arise under" federal law, as long as it is “related to” the bankruptcy case.
Next, the Sixth Circuit quickly disposed of the creditor’s statutory challenge to the bankruptcy court's authority to enter final judgments. The Court noted that whether the bankruptcy court can enter a final judgment depends on whether the matter is "core" or "non-core" (the former permitting the bankruptcy court to enter a final judgment, and the latter requiring the bankruptcy court to submit proposed findings of fact and conclusions of law to the district court). The Court rejected the creditor's argument that the debtor's claims were "non-core" and as a result the bankruptcy court had no authority to enter the judgment because the creditor forfeited his objection by expressly admitting in his own pleadings that the claims were core.
The third argument made by the creditor raises the constitutional issues from Stern. The creditor argued that the judgment against him was entered in violation of the Constitution because it was entered by a judge exercising Article III “judicial power” despite the judge’s lack of Article III tenure and salary protections. The Sixth Circuit analyzed the debtor’s and United States’ argument that the right to an Article III judge (exercise of power) is a personal “waivable right” rather than a non-waivable structural principle. The Sixth Circuit rejected that idea as too narrow, and reasoned that Article III mandates "judicial power" be vested in judges whose tenure and salary are protected. In that regard, the Court stated that Article III could not serve its purpose in the system of checks and balances if the other branches of the Federal Government were permitted to confer Article III "judicial power" on entities outside of Article III. Specifically, to the extent Congress is allowed to shift the "judicial power" to judges without Article III protections, the Judicial Branch would become weaker and less independent than it was intended to be. As a result, the Sixth Circuit held that the creditor's objection implicates not only his personal rights, but also the structural principle advanced by Article III and that principle is not the creditor's right to waive.
The Court went on to review the public rights doctrine and the distinction between public and private rights. Noting that bankruptcy courts cannot enter a final judgment as to claims involving liabilities between individuals unless a claim is a “public right” exception to Article III, the Court revisited the cases reviewed by the United States Supreme Court in Stern. The Court noted that the difference between a public and a private right is that a public right is one relating to “restructuring a debtor-creditor relations” whereas a private right is the adjudication of a state created right, which is served to augment the bankruptcy estate versus determining claims. The Court concisely summarized the following principle from Stern: “When a debtor pleads an action under federal bankruptcy law and seeks disallowance of a creditor’s proof of claim against the estate . . . the bankruptcy court’s authority is at its constitutional maximum. . . . But when a debtor pleads an action arising only under state law, as in Northern Pipeline; or when the debtor pleads an action that would augment the bankruptcy estate, but not ‘necessarily be resolved in the claims allowance process,’ . . . then the bankruptcy court is constitutionally prohibited from entering final judgment.”
The Sixth Circuit went on to recognize that the bankruptcy court had authority to enter a final judgment disallowing the creditor’s claim because it directly relates to the claim’s allowance process. The Court noted that one of the bankruptcy court’s basic functions in administering an estate is in the claim’s allowance process. Because the debtor did not seek affirmative relief in his disallowance claim, the bankruptcy court had authority to enter a final judgment disallowing the claim.
Contrarily, in regard to the debtor’s second claim -- which affirmatively sought money damages -- the Court held that the Bankruptcy Court’s entry of judgment awarding money damages was in violation of Article III. The Sixth Circuit stated that “for a bankruptcy court to enter a final judgment as to claims that seek an award of damages to the estate, there must have been, at the outset of the claim’s disallowance process, ‘reason to believe that the process of adjudicating [the] proof of claim would necessarily resolve’ the damages claim.” In this case, debtor’s affirmative claim required proof of facts beyond those for disallowance of the claim. Therefore, there was no reason to believe that the disallowance of claims would necessarily resolve the affirmative claim for money damages. As a result, the entry of judgment with respect to money damages was entered in violation of Article III.
As a remedy, the Court remanded the case to the bankruptcy court to submit proposed findings of fact and conclusions of law to the district court for entry of a final judgment. The Sixth Circuit reasoned that the submission of proposed findings of fact and conclusions of law was the appropriate remedy given the debtor’s affirmative claim was not a core proceeding. A core proceeding “either invokes a substantive right created by federal bankruptcy law or one which could not exist outside the bankruptcy.” Neither was the case here. Debtor’s affirmative claims were state law claims for fraud that could be brought outside of the bankruptcy. The debtor's claims were non-core and only “related to” the bankruptcy estate, and as a result, the bankruptcy court must submit proposed findings of fact and conclusions of law to the district court. The Sixth Circuit also noted that although the parties alleged in the bankruptcy court that all of the debtor’s claims were core and, as noted above, the creditor forfeited his right to argue that the claims were non-core, the creditor’s attempt to waive his own rights does nothing to diminish the bankruptcy court’s authority under § 157(c)(1).
This case is significant as it provides guidance to bankruptcy practitioners regarding the holding from Stern. The Sixth Circuit has made it clear that parties may not waive the right to an Article III judge. The Court also clarified that a bankruptcy court is constitutionally prohibited from entering a final judgment when the claim for money damages would only augment the bankruptcy estate and would not necessarily be resolved in the claims allowance process. In those instances, the bankruptcy court will be required to issue a report and recommendation to the district court for the entry of a final judgment.
1 131 S. Ct. 2594 (2011).
2 Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 72 N. 26 (1982) (plurality opinion).
Patricia concentrates her practice in the areas of Bankruptcy, and Banking and Finance. She assists firm attorneys in the representation of secured creditors in complex bankruptcy issues; represents Chapter 7 Trustees; conducts research of Bankruptcy Code and case law; drafts pleadings, complaints, motions and briefs; attends Federal Bankruptcy court hearings; conducts discovery.View All Posts by Author ›