Creditors’ Rights after Stern v. Marshall
Last summer, the U.S. Supreme Court announced their decision in the case of Stern v. Marshall and since that time, bankruptcy lawyers and bankruptcy judges (especially) have been walking around with perplexed and worried looks on their faces. Chief Justice Roberts characterized the question decided as “narrow,” and not resulting in a “meaningful change [in] the division of labor in the …[bankruptcy code].” Then why the furrowed brows?
The facts of the case are by now well known, but here is a synopsis.
The case began in a Texas probate court. Because Howard Marshall failed to include his wife, Vickie Lynn Marshall (popularly known as Anna Nicole Smith) in his will, Ms. Marshall brought an action against Pierce Marshall (Howard Marshall’s son) alleging fraudulent interference with Howard Marshall’s inter-vivos trust.
After her husband’s death, Ms. Marshall filed for bankruptcy. Pierce Marshall filed a proof of claim in Ms. Marshall’s bankruptcy, alleging damages based upon Ms. Marshall’s defamation of him (a tort action). Pierce Marshall also filed a non-dischargability complaint. Ms. Marshall responded by asserting truth as a defense, and counterclaimed for tortious interference with a testamentary gift.
The Bankruptcy Court ruled in favor of Ms. Marshall on her counterclaim, awarding her $425 million. Pierce Marshall alleged that the Bankruptcy Court lacked jurisdiction to hear the counterclaim, because it was not a “core proceeding.” The Bankruptcy Court disagreed, stating that it had the power to enter judgment on the counterclaim under § 157(b)(1).
The District Court disagreed, deciding that it was unconstitutional under Northern Pipeline Constr. Co. v. Marathon Pipeline, 458 U.S. 50, 79 n.31 (1982), for the Bankruptcy Court to enter final judgment on the claim. (Marathon held that a bankruptcy court could not finally decided a state law claim against an entity that was not otherwise part of the bankruptcy proceeding.) The Court of Appeals in Stern reversed the District Court (on a different ground) but found that a counterclaim under § 157(b)(2)(C) is properly a “core proceeding arising in a case under the [Bankruptcy Code] only if the counterclaim is so closely related to [a creditor’s] proof of claim that the resolution of the counterclaim is necessary to resolve the allowance or disallowance of the claim itself.”
The Supreme Court granted certiorari to resolve the question of whether a bankruptcy court could constitutionally enter a final judgment on an otherwise non-core tort cause of action asserted as a compulsory counterclaim to a creditor’s non-dischargeablility complaint.
The Supreme Court’s Holding
Justice Roberts, writing for a 5-4 majority (with J. Scalia concurring), held that although the Bankruptcy Court had statutory authority to enter judgment on the counterclaim under § 157(b)(2)(C), it lacked constitutional authority to do so. Relying on Marathon, Justice Roberts observed that since Bankruptcy Courts are not Article III courts, they were not vested with the authority to decide state law tort (or contract) claims. Since the counterclaim at issue in the Stern case was “not a necessary part of the claims process,” as it involved “legal and factual questions that would not “necessarily” be resolved in connection with the adjudication of Pierce’s claim,” it could not be adjudicated with finality by a bankruptcy court. The court discussed public rights (those rights so infused with a federal governmental action) versus private rights (a matter, from which its nature is the subject of a suit at the common law, or in equity, or admiralty) and deemed the compulsory counterclaim at issue to be a matter of private rights.
The Court, in explicitly declaring that Congress, “in one isolated respect,” exceeded the Article III limitation, was adamant that the “narrow” holding would not “meaningfully change” the courts’ division of labor. “We are not convinced that the practical consequences of such limitations on authority of bankruptcy courts to enter final judgments are … significant…."
The Practical Considerations for Creditors.
Although the holding in Stern addresses a rather narrow issue – the question of whether a bankruptcy court has the constitutional authority to enter a final judgment on an otherwise non-core tort cause of action asserted as a compulsory counterclaim in a bankruptcy case – the case raises significant new matters for consideration by any business enterprise or individual that may end up engaged in litigation with a debtor entity – that is to say – all of us. Ultimately, Stern will serve to complicate the decision making tree for individual creditors contemplating the filing of a proof of claim in a bankruptcy case, as well as for parties who may find themselves enmeshed in litigation with a debtor.
Some of the key questions and issues creditors ought to be thinking about are:
- What is the likelihood of litigation with a debtor entity?
- The issues raised by Stern must now factor into strategic decision making, whether the goal is to minimize or maximize a bankruptcy court's involvement in a case.
- Does the increased likelihood of litigating counterclaims in a non-bankruptcy court, when a creditor has chosen not to file a proof of claim, offer a strategic advantage to creditors?
- Consider: Should a creditor file a proof of claim, although such filing may subject the creditor to broader bankruptcy court jurisdiction, i.e., does the potential recovery on the claim outweigh the risk of being subjected to litigation in a bankruptcy court?
- Consider: Where a creditor has not filed a proof of claim, a bankruptcy court may not have the constitutional authority to decide cases raising a number of legal theories, including claims for the avoidance of allegedly preferential or fraudulent transfers, equitable subordination, lien avoidance, lender liability, etc., in the aftermath of Stern.
- Parties should evaluate the litigation risks associated with claims traditionally asserted by the bankruptcy trustee in the light of Stern. Do non-debtors have additional leverage in settlement discussions, since Stern may mean that plaintiffs will have increased litigation costs and risks?
- Will Stern serve to prevent reorganized entities or creditor trusts from using a bankruptcy court to litigate certain post-confirmation claims? (See Judge Gerber’s Opinion from the Bench in Bearing Point.)
The post-Stern v. Marshall world is now more complicated for creditors in bankruptcy cases. While it appears that bankruptcy courts continue to have the constitutional authority to decide many claims, the full extent of that authority is less clear than ever. While the opinion may be narrow in scope, the Court offers a very broad rationale for its decision. As noted in an earlier post on this blog on March 6, 2012, the Fifth Circuit recently declined to apply Stern v. Marshall to the U.S. Magistrate. The scope of the decision’s impact has yet to be fully realized.
--Ira L. Herman and Lois R. Lupica, Thompson & Knight LLP
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