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Carolina Bankruptcy Judges Discuss Jurisdiction Issues

By Columbia – Lexington Bankruptcy Attorney Lex Rogerson

Recent and upcoming decisions by the US Supreme Court could reshape the bankruptcy system as we know it.

There’s no such thing as the bankruptcy court.bankruptcy court building

That was former North Carolina bankruptcy judge Thomas Waldrep‘s synopsis last weekend in a joint presentation with current SC chief bankruptcy judge David Duncan to the South Carolina Bankruptcy Law Association.  And he was right.

What?? We all know there’s a bankruptcy court.  We’ve been there, we’ve argued cases before it, and we know the judges. But Judge Waldrep’s point is that what we know as the bankruptcy court is nothing more than a subdivision of the US District Court. That was determined by the Supreme Court in 1982 and by Congress’s reaction in 1984. And when the high court reiterated the point in 2011 — in a case involving a famous stripper and Playboy model — it called into question whether the court will continue to look like the one we have come to know.

The Northern Pipeline case

When Congress enacted the modern Bankruptcy Code in 1978, it also set up a new, entirely separate system of bankruptcy courts to control the process. Bankruptcy judges were to be appointed by the President for 14-year terms, and they had full power to decide issues related in virtually any way to a pending bankruptcy filing.

Within four years, a huge problem developed. The Supreme Court held that the 1978 provisions granting bankruptcy courts permission to adjudicate all kinds of disputes as long as they were “related to” bankruptcy cases was unconstitutional.  Northern Pipeline Const. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982).

Article III of the Constitution says that the “judicial Power of the United States” is vested in judges that must be appointed for life (during good behavior) and whose pay cannot be reduced. The framers thought these restrictions necessary to assure that judges were independent of the political branches of government. Article I allows Congress to establish other courts for special purposes, but only Article III judges can exercise general judicial power. By giving bankruptcy judges wide power to hear matters related to bankruptcy cases, Congress allowed these Article I judges to decide things that were reserved to Article III judges, and that violated the Constitution.

After Northern Pipeline, Congress in 1984 enacted a new system under which bankruptcy judges were appointed by the US Courts of Appeal, though still for 14-year terms.  District courts, which are Article III courts, were authorized to refer bankruptcy cases and related litigation to bankruptcy judges. Every district court in the country adopted a local rule referring these matters to bankruptcy courts. In effect, bankruptcy judges were special-purpose judges serving under the district courts, and they could still hear almost anything arising in or related to a bankruptcy case. That solved the problem — or so we thought.

Enter the stripper

Vickie Hogan, a one-time exotic dancer and Playboy model better known as Anna Nicole Smith, married Howard Marshall, a Texas multi-millionaire several decades her senior. He died about a year after the marriage. Shortly before his death, Vickie sued his son Pierce for fraudulently convincing Howard to leave her out of his estate plan. Without the expected inheritance, Vickie was insolvent, and shortly thereafter she filed bankruptcy.

Pierce filed a claim in Vickie’s bankruptcy case contending that she had defamed him by accusing him of fraud and also filed an adversary proceeding contending that claim was not dischargeable in bankruptcy. Vickie countersued for interfering with her inheritance.  The bankruptcy court ruled for Vickie on both claims and awarded her over $400 million in damages. After Pierce appealed this award, both Vickie and Pierce died, but their estates continued the litigation.

The Supreme Court first decided that Congress had specifically included counterclaims like Vickie’s among the “core matters” in which bankruptcy court could enter a final decision. But that did not end the issue. Instead, the question became whether this authority was consistent with the Constitution. On that question, the Court said no.  Stern v. Marshall, 131 S.Ct. 2594 (2011).

To reach this conclusion, the Court had to identify what kinds of decisions represent exercise of the federal judicial power that is reserved to Article III judges. While that power may not include ruling on matters of bankruptcy law or administration, it does include ruling on garden-variety statutory or comm0n-law claims that have traditionally been decided by non-bankruptcy courts — torts, contracts, general commercial claims, etc. Because Vickie’s counterclaim fell in this category, and because the bankruptcy court did not need to decide that counterclaim in order to resolve Pierce’s claim or decide whether it was dischargeable, the award to Vickie was an exercise of judicial power. The bankruptcy court therefore could not enter a final order on that counterclaim.

The aftermath

If bankruptcy courts can’t rule on such matters, who can?

Most districts have adopted rules that require bankruptcy judges, when they encounter a “judicial power” claim, to file a proposed ruling with the district court. Then the district judge, who holds Article III power, makes the final ruling. The smart money says this approach will pass muster. But no one believes this is the end of the story.

The Supreme Court carefully stated its ruling in Stern was a narrow one. Whether or not that is true, it certainly left many questions unanswered.

  • Aside from counterclaims, which of the many proceedings that bankruptcy judges have traditionally decided are matters of “judicial power” and which are bankruptcy administration?
  • Can the parties to a dispute involving “judicial power” consent for a bankruptcy judge to make a final decision? And is the proposed ruling procedure consistent with the Constitution? These questions are currently before the Supreme Court.
  • Could the restriction on final orders by bankruptcy judges mean bankruptcy courts become obsolete or even abolished?

This is an issue that will not seem to go away. No one really knows where we’re headed. Fasten your seat belts, folks, because we could be in for a bumpy ride.

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