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A Baby Step Forward:  <i>Executive Benefits Insurance Agency v. Arkison</i>

A Baby Step Forward: Executive Benefits Insurance Agency v. Arkison

In Executive Benefits Insurance Agency v. Arkison, 2014 BL 158582, 189 L. Ed. 2d 83 (2014), a unanimous U.S. Supreme Court took a small step forward in clarifying the contours of a bankruptcy judge’s jurisdictional authority. The case explained that when a bankruptcy court is confronted with a claim that is statutorily denominated as "core," but is not constitutionally determinable by a bankruptcy judge under Article III of the U.S. Constitution, the bankruptcy judge should treat such a claim as a non-core "related to" matter that the district court reviews anew. The ruling eliminates any supposed statutory gap created by the Supreme Court’s 2011 Stern v. Marshall decision, but Arkison nonetheless leaves many potentially larger jurisdictional and constitutional questions unanswered.

The Dispute

Nicholas Paleveda and his wife owned Bellingham Insurance Agency, Inc. ("Bellingham"). In early 2006, Bellingham became insolvent and ceased operating. A day later, Paleveda used Bellingham's funds to incorporate another insurance agency, Executive Benefits Insurance Agency, Inc. ("EBIA"). Paleveda and others thereafter initiated a scheme to transfer assets from the defunct Bellingham to the new EBIA. In June 2006, Bellingham filed for bankruptcy relief in the Western District of Washington. A chapter 7 bankruptcy trustee, Peter Arkison, was appointed to administer Bellingham’s estate. After his appointment, Arkison commenced suit in the bankruptcy court against EBIA and others to, among other things, avoid the fraudulent transfer of Bellingham’s assets.

The bankruptcy court rendered summary judgment in favor of Arkison on all claims. EBIA appealed to the district court. On appeal, the district court conducted a de novo review, affirmed the bankruptcy court’s decision, and entered judgment for Arkison. EBIA again appealed, this time to the U.S. Court of Appeals for the Ninth Circuit. While the case was pending before the circuit court, the Supreme Court issued its now well-known Stern v. Marshall opinion. In light of Stern, EBIA moved to dismiss the appeal, contending that the bankruptcy court could not have constitutionally determined the fraudulent transfer claims against it.

The Ninth Circuit denied EBIA's motion to dismiss. While it held that the fraudulent conveyance claim was not, under Stern, constitutionally determinable absent consent of the parties, the Ninth Circuit held that EBIA had impliedly consented to the bankruptcy court determining the summary judgment motion. The court also held that the bankruptcy court’s ruling on the summary judgment motion could be treated as a report and recommendation subject to de novo review by the district court.

EBIA petitioned for certiorari, identifying two fundamental questions: (i) whether litigants can consent to the exercise of the judicial power of the U.S. by a non-Article III judge in the form of entry of a final, enforceable judgment; and (ii) whether bankruptcy judges have statutory authority to propose findings of fact and conclusions of law in "core" proceedings.

The Supreme Court granted certiorari.

Bankruptcy Jurisdiction in a Stern v. Marshall World

Article III, Section 1 of the U.S. Constitution provides that "[t]he judicial Power of the United States, shall be vested in one supreme Court, and in such inferior Courts as the Congress may from time to time ordain and establish." The Article states that such judges "shall hold their Offices during good Behaviour, and shall, at stated Times, receive for their Services a Compensation, which shall not be diminished during their Continuance in Office."

Given these provisions, the exercise of the "judicial Power of the United States" is vested in so-called Article III judges. Bankruptcy judges, however, are not Article III judges. They do not have life tenure, and their salaries are subject to diminution. Instead, bankruptcy judges are technically authorized under Article I, which governs the legislative branch and authorizes the establishment of a uniform system of federal bankruptcy laws. Under principles of separation of powers, bankruptcy judges cannot exercise the judicial power reserved for Article III judges.

Thirty-two years ago, in Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), the Supreme Court struck down certain provisions of the Bankruptcy Act of 1978 because it conferred Article III judicial power upon bankruptcy judges who lacked life tenure and protection against salary diminution. After more than two years of delay, Congress enacted the Bankruptcy Amendments and Federal Judgeship Act of 1984 to fix the statutory infirmity identified in Marathon. The jurisdictional scheme for bankruptcy courts continues in force today. Sort of.

Congress established the jurisdiction of the bankruptcy courts in the Federal Judicial Code, 28 U.S.C. §§ 1 et seq. ("title 28"). As amended in 1984, title 28 provides that the district courts shall have "original and exclusive jurisdiction of all cases under title 11" and "original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11." Title 28 further provides that each bankruptcy court is "a unit of the district court" in the federal district where it is located. District courts may—but need not—refer cases and matters within the scope of bankruptcy jurisdiction to the bankruptcy courts.

Title 28’s jurisdictional strictures for bankruptcy courts provide that "Bankruptcy judges may hear and determine all cases under title 11 and all core proceedings arising under title 11, or arising in a case under title 11." Thus, a bankruptcy court may enter a final order with respect to all bankruptcy cases before it and all matters within the scope of its "core" jurisdiction. Such a final order is subject to appellate review by the applicable district court or bankruptcy appellate panel (and thereafter, by the applicable court of appeals).

A bankruptcy court may also hear a non-core proceeding that that is "related to" a bankruptcy case, but, absent consent of the litigants, a bankruptcy court cannot enter a final order when exercising related to jurisdiction. Instead, it may issue only a proposed order, which is reviewed de novo by the district court.

In 2011, the Supreme Court in Stern v. Marshall, 564 U.S. ___, 131 S. Ct. 2594 (2011), shook up the jurisdictional scheme established by statute and declared that a portion of the Federal Judicial Code addressing the bankruptcy courts’ core jurisdiction was unconstitutional. According to Stern, the 1984 jurisdictional scheme did not adequately address the Marathon issue, at least not in all instances. Stern held that even though bankruptcy courts are statutorily authorized to enter final judgments on various categories of bankruptcy-related claims, Article III prohibits bankruptcy courts from finally adjudicating certain of those claims. Specifically, Stern ruled that a bankruptcy court lacks constitutional authority under Article III 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.

While Stern itself purported to be a narrow decision, it has given rise to a great deal of litigation concerning whether or not a particular claim, though statutorily denominated as core, is in fact aclaim that is finally determinable by a bankruptcy judge. Further, in the years since Stern, courts have also struggled with the following issues: (i) how should a bankruptcy court deal with a claim that, while statutorily denominated as core, is not in fact constitutionally determinable by an Article III judge; and (ii) the effect of a party’s consent to adjudication of a claim of this nature by a bankruptcy court.

In Executive Benefits Insurance Agency v. Arkison, the Supreme Court teased the bankruptcy community with the possibility of resolving both of these issues, but ultimately decided just the first.

Filling the Statutory Gap

Stern held that some claims, while labeled in the statute as core, may not be adjudicated by a bankruptcy court as a constitutional matter. The existence of such "Stern claims" threatened to create a gap in section 157 of title 28, the statute that addresses the scope of matters that may be heard and determined by a bankruptcy court.

The statute provides a limited menu of options. The entire world of bankruptcy jurisdiction is divided into three categories: (i) bankruptcy cases; (ii) core claims; and (iii) non-core, but "related to" claims. As noted, bankruptcy courts can enter final orders with respect to core matters. Bankruptcy courts may (absent consent) enter only proposed findings of fact and conclusions of law with respect to non-core related to matters. Nowhere does the statute expressly provide for a procedure where a bankruptcy court can enter proposed findings of fact and conclusions of law with respect to a statutorily-denominated core matter; instead, the statute presumes that a bankruptcy court may finally determine all statutorily-denominated core claims. Thus, in a post-Stern world, the question arose—what does a bankruptcy court do with a statutorily core claim that it cannot finally determine under Article III? Stern did not provide the lower courts with any directions on how they should proceed with respect to such Stern claims.

In Arkison, the petitioner, EBIA, asserted that the gap rendered the bankruptcy court powerless to act on Stern claims and that all such claims must be heard by district courts in the first instance. A unanimous Supreme Court disagreed. The statute, according to the Court, permits a Stern claim to proceed before the bankruptcy court as a non-core matter.

To reach this result, the Court first looked to the severability provision contained in the Federal Judgeship Act of 1984 (98 Stat. 344), which provides that "[i]f any provision of this Act or the application thereof . . . is held invalid, the remainder of this Act . . . is not affected thereby." This severability provision was dispositive in the Court’s view. This is because, when a court identifies a claim as a Stern claim, it has necessarily "held invalid" the application of the "core" label to such claim, along with the associated procedures. With the "core" option invalidated and unavailable to such a claim, the Court explained, the only other category available is to treat such claim as non-core or "related to" the bankruptcy. Therefore, as a "related to" claim, the bankruptcy court could submit to the district court proposed findings of fact and conclusions of law, which would then be reviewed de novo.

The Court explained that this conclusion is consistent with its general approach to severability—absent statutory text or context to the contrary, Congress generally prefers the Court to give effect to a partially unconstitutional statute than to have no statute at all. Here, nothing indicated to the Court that Congress wished to place Stern claims in "limbo." According to the Court, doing so would unnecessarily change the "division of labor" set out in the statute between bankruptcy judges and district court judges. Having reached this conclusion, the Court easily determined that the fraudulent conveyance claims at issue were non-core "related to" claims as to which the bankruptcy court could submit proposed findings of fact and conclusions of law.

Finally, the Court explained that, although the bankruptcy court did not style its entry of summary judgment as a report and recommendation, and although the district court did not re-label the bankruptcy order as a mere proposed findings of fact and conclusions of law, the district court effectively cured any Stern problem by reviewing the matter de novo and entering a judgment of its own. In essence, EBIA received exactly what it asserted it was entitled to—a de novo review by an Article III judge.

The Open Question of Consent

The Court did not reach the question of whether EBIA could and, in fact, did consent to adjudication of the matter before the bankruptcy court. Because the district court's de novo review and entry of its own final judgment cured any potential error, the question of the litigants’ consent to adjudication before the bankruptcy judge did not matter. In other words, the Court did not need to reach the issue of whether the parties consented to the bankruptcy court’s final determination of the matter because the bankruptcy court’s judgment was reviewed de novo by the district court.

Outlook

Arkison is a welcome clarification of how the bankruptcy statute should allocate work among the bankruptcy and district courts with respect to Stern claims. The opinion, however, does not resolve some of the larger constitutional and jurisdictional questions that have arisen since the Court’s last foray into this complicated area of the law. For this, bankruptcy professionals will need to await the next installment from the Supreme Court, which may come in the Court’s next term.

In particular, Arkison plugs the potential gap in the statute created by Stern. But Arkison does nothing to help explain which claims, as a constitutional matter, can be finally determined by a bankruptcy judge. Until there is additional guidance, disputes over whether a claim is a Stern claim or not will likely continue to be a fertile source of conflict in bankruptcy cases throughout the country.

In addition, the Arkison Court expressly "reserve[d] … for another day" the question of "whether Article III permits a bankruptcy court, with the consent of the parties, to enter final judgment on a Stern claim." This question is significant. For example, until there is guidance from the Supreme Court, litigants may feel emboldened to challenge a bankruptcy court’s adjudication of "related to" matters when all parties have consented or, for that matter, the propriety of bankruptcy appellate panels (which consist entirely of bankruptcy judges and hear appeals from bankruptcy judges in several circuits). Arguably, the consequences of a ruling by the Court on consent could extend to disputes far beyond the context of bankruptcy law, including such broadly used mechanisms as arbitration and the use of magistrate judges—both of which were discussed during oral argument before the Court.

It bears noting that most, but not all, lower courts had already come to the same conclusion reached by the Supreme Court with respect to the so-called statutory gap. The district courts for two important jurisdictions—the District of Delaware and the Southern District of New York—had issued amended standing orders of reference that expressly provided for bankruptcy courts to issue reports and recommendations with respect to Stern claims. In this sense, Arkison is a helpful step in clarifying the post-Stern world of bankruptcy jurisdiction—but only a baby step.

As it turns out, the lower courts and bankruptcy professionals may not have to wait long for the Court’s next step with respect to these issues. Shortly after deciding Arkison, the Court granted certiorari in Wellness Int’l Network v. Sharif, No. 13-935, 2014 BL 182626 (July 1, 2014). That case appears likely to present the issue of consent, and it also provides the Court with an opportunity to define further the post-Stern landscape.

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