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Bankruptcy judges, lawyers frustrated by ‘Stern’ ruling

U.S. Bankruptcy Court Judge Barbara Houser’s job is a lot harder than it used to be, and she is not afraid to admit it.

The problem for Houser and her colleagues, as well as practitioners across the country, is the U.S. Supreme Court’s 2011 Stern v. Marshall decision, which limited the ability of judges to hear and rule on claims that regularly arise outside the Bankruptcy Code.

“Many are debating the breadth of the Supreme Court’s decision in Stern,” Houser, a judge in the Northern District of Texas, recently wrote in Soporex v. Reed. “It is absurd to think … the bankruptcy courts can now do nothing with respect to these types of claims. … The arguments are interesting and, in some instances, mind-numbing.”

Bankruptcy lawyers have been lamenting the confusion created by Stern, a case that stemmed from the long-running battle between the estate of the late model Anna Nicole Smith and the son of her late husband, J. Howard Marshall.

“Typically, the more cases that are decided, the more clarity you get,” said George Zimmerman, a New York lawyer who heads the litigation practice at Skadden, Arps, Slate, Meagher & Flom. “After Stern, it is the opposite.”

Mark DeGiacomo of Boston’s Murtha Cullina said the biggest problem with the decision is that it calls into question the ability of bankruptcy judges to issue binding decisions on matters typically presented to them.

“Stern ends up throwing into doubt what a bankruptcy judge really can do in terms of issuing final rulings,” he said. “The reason it’s received so much attention is that the Supreme Court basically says that state-law issues can’t be ruled on by non-Article III judges, which is not something a lot of people saw coming.”

Court skipping

According to DeGiacomo, practitioners have interpreted Stern to mean that fraudulent conveyance matters, which are prevalent in bankruptcy proceedings, can no longer be decided in Bankruptcy Court. There is now a much larger class of cases in which all a judge can do is issue proposed findings of facts and rulings of law, which then must be reviewed on a de novo basis by a U.S. District Court judge, he said.

In an effort to avoid the time and cost of addressing the same issue in two different courts, many litigants are now opting to skip Bankruptcy Court altogether, DeGiacomo said.

“What you’re seeing and are going to continue to see are defendants in adversary proceedings, which involve state-law issues, moving for withdrawal from Bankruptcy Court so their cases can be tried in the first instance in federal District Court,” he said.

Justin Dion of Bacon Wilson in Springfield, Mass., said that such venue-shifting works to the disadvantage of the litigant with less money.

Dion, chairman of the Hampden County Bar Association’s Bankruptcy Committee, said the Stern dissent accurately predicted the ruling would create a constitutionally required game of “jurisdictional ping pong” between the two courts.

“What it does is empower the party with more funds because they know they can drag the other party through two federal court proceedings, which is not cheap,” he said. “The end result is going to be more settlements because some people are not going to be able to spend all that money litigating an issue in two different places.”

Patricia Antonelli of Partridge, Snow & Hahn in Providence, R.I., said the case is still the topic of conversation at nearly every bankruptcy conference she attends.

Although the Stern majority wrote that the opinion was intended to be interpreted narrowly, Antonelli said some judges have clearly struggled with that notion.

“If I’m going to give advice to a client about whether a claims dispute can be decided by a bankruptcy judge, the idea that the case could be moved to another court where the calendar may be more bogged down, and it may take me longer to get to my resolution, is problematic,” Antonelli said. “Lawyers want to be able to advise clients with certainty. The concern now is that we really don’t know what’s going to happen.”

Anna Nicole’s impact

Stern began as a battle over J. Howard Marshall’s estate. Anna Nicole Smith subsequently filed for bankruptcy, and Marshall’s son filed a proof of claim alleging he should recover damages for defamation.

Smith then filed a counterclaim for tortious interference with the gift she expected from her late husband. She won on her counterclaim in Bankruptcy Court, but a state court ruled against her on her claim for the inheritance.

The Supreme Court ultimately found that the Bankruptcy Court did not have the authority to rule in Smith’s favor, because her claim was “a state law counterclaim that [was] not resolved in the process of ruling on a creditor’s proof of claim.”

Such claims could only be taken up by Article III federal courts, the court held.

Despite the court’s declaration that Stern was narrow and limited to its facts, bankruptcy lawyers and judges are now trying to figure out just what the ruling means in cases that involve state-law-based claims and counterclaims.

“My frustration with Stern is that it offers virtually no insight … so that I can again proceed with at least some assurance that I will not be making the same constitutional blunder,” wrote Bankruptcy Court Judge Jeffrey R. Hughes of the Western District of Michigan in Meoli v. Huntington Nat’l Bank (In re Teleservices Group, Inc.).

Complicated scheme

Before Stern, bankruptcy judges had the power to hear and rule on core proceedings. In non-core proceedings, they could only submit proposed findings of fact and conclusions of law to the District Court.

In the recently decided Kirschner v. Agoglia, Bankruptcy Court Judge Robert Drain noted that Stern seems to have complicated the scheme by creating “a new type of proceeding: a core proceeding in which the bankruptcy judge is constitutionally precluded from entering a final order or judgment.”

“This, in turn, raises the issue whether there is a gap in the statutory scheme preventing the [Bankruptcy] court’s submission of proposed conclusions of law to the district court if a matter falls into the new ‘core but precluded’ category,” Drain wrote.

Drain, who sits in the Southern District of New York, ultimately ruled that he did have the authority to issue a final ruling on a claim of fraudulent transfer, or at the very least issue an opinion that could be treated as proposed conclusions of law and a recommendation to the District Court.

But he noted that other bankruptcy judges have come to different conclusions, leaving the area of law far from settled.

Some judges wonder if they should err on the side of safety and work on the assumption that they do not have the ability to take up matters that do not fall squarely within the Bankruptcy Code.

“One alternative would be to play it safe and simply refer without reflection every future determination I make to a district judge for his or her final review,” Hughes wrote in Meoli.

“However, I do not see how I can do so in good faith given [federal law’s] direction that I must decide even in instances when not requested whether I have the ability or not under that section to enter a final order. Moreover, I suspect that the Article III judges in my district would not be pleased with the extra workload such an approach would impose upon them.”

Those judges who do decide to adjudicate claims are expressing trepidation.

In Sanders v. Muhs, Judge Marvin Isgur of the Southern District of Texas ruled that a fraudulent transfer claim was within the “public rights” exception to Article III’s limitation on bankruptcy courts’ jurisdiction, thereby allowing him to rule.

Still, he acknowledged that coming to that conclusion was not easy after Stern.

“The broader applicability of the … decision [in Stern] remains unclear,” Isgur said. “The court’s authority over matters involving state-law causes of action is particularly questionable.”

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