When can a Bankruptcy Court enter a final decision? The Supreme Court punts, and muddies the waters

In rendering a narrow and less than clear ruling on the powers of Bankruptcy Courts, the Supreme Court missed an opportunity to solve a problem and instead has made it worse.

Since the 1982 Marathon decision of the US Supreme Court, we have known that Bankruptcy Judges’ cannot always  enter a final ruling the same as Article III District Court judges (who are granted lifetime tenure and who have to go through the Congressional confirmation process). As Article I judges appointed through the Executive Branch, their powers have been limited to certain “core” areas intrinsic to the Bankruptcy Process. Originally, Congress in enacting the 1979 Bankruptcy Code gave them broad powers. In 1982 this was struck down by Marathon.   In response, Congress amended the Bankruptcy Code to give Bankruptcy Judges the power to enter final rulings in certain defined “core” proceedings considered so central to the federal bankruptcy administration process as to fit within what the Constitution allows Article I judges to do. (examples are challenges to creditor claims). For anything else (so-called “related-to” jurisdiction involving matters that had a connection to the bankruptcy case), the issue either had to go to the District Court, or the Bankruptcy Court could only issue proposed findings of fact and conclusions of law and then submit them to the District Court for “de novo” review. At first, it seemed the District Courts would be inundated with bankruptcy related disputes.

This problem was initially solved by making the Bankruptcy Courts arms of the District Courts (the same as US Magistrates) under standing orders of reference which sent all bankruptcy cases and issues to them. For years, the statutory designation of “core” vs “non-core” jurisdiction  worked  fairly well. And it has been generally assumed that non-core matters could be finally decided by consent of the parties. In 2012, all that unraveled as the Supreme Court in Stern v Marshall held that at least one of these “core” categories did not pass muster, so that a counterclaim for tortious interference either had to be heard by the District Court, or else if heard by the Bankruptcy Court, that court could only issue proposed findings and conclusions.

In Executive Benefits Insurance Agency v Arkison, decided June 9, 2014, the Supreme Court was asked to decide if the parties’ consent to a final ruling by a bankruptcy court passed Constitutional muster where the action, to avoid a fraudulent transfer, was clearly one that only an Article III court could enter a final judgment upon.  Had that been decided, a lot of uncertainty might have been avoided.

In Arkison, a trustee sued to avoid a fraudulent transfer and bring money or property into the Bankruptcy Estate. The defendant did not raise lack of Article III jurisdiction when the Bankruptcy Court heard the trustee’s motion for summary judgment, and ruled against it. Instead it took an appeal to the District Court, again not raising this issue. Only on a further appeal, when Stern was decided, did it claim that the Bankruptcy Court never had jurisdiction to rule against it because instead of propsed findings of facts and a proposed judgment, it had issued a final ruling that only the District Court had the power to hand down. That was the case that was presented to the Supreme Court.

The Supreme Court ruling has been long-awaited with some degree of trepidation. Bankruptcy Judges handle an enormous docket of cases involving specialized law and practice. If all of this or even a major portion of this work were shifted to District Court judges, the entire bankruptcy system would grind to a halt. A ruling in favor of the defendants would also place in question whether US Magistrates had any power to decide anything.

The Court declined to rule on whether consent of the parties was sufficient to permit a Bankruptcy Court to make a final trial court ruling, and that is unfortunate. Most bankruptcy related matters are decided this way without objection. Instead, the Court held that where the District Court is given an opportunity to review that ruling on appeal in the same plenary manner as should have happened, the constitutional defect is cured. This was possible in this case only because, unlike an appeal of a ruling after trial where deference is given to the lower court findings of fact, no such deference applied on an appeal of a summary judgment.

After Arkison and Stern, it is not always clear where the line should be drawn between what a Bankruptcy Court can decide for itself and for what it can only issue a proposed decision. At least one court, the day after the decision, opined that when in doubt, the matter goes to the District Court to decide where the line is to be drawn.

Sadly, Arkison does not even say whether parties’ consent to a final ruling in the Bankruptcy Court resolves the issue and cures any defect if the Bankruptcy Court exercises more power than it is supposed to. Had the Supreme Court so ruled, much potential mischief might be avoided. With the question in doubt, and under princples that lack of jurisdiction can always be raised, a party might  proceed to trial, silent on this issue, then when disappointed in the result, object that the Bankruptcy Court lacked power to render a binding ruling. What if these objections are not raised until long after the time for appeal, when for example the successful party seeks to enforce the Bankruptcy Court judgment? The possibilities for gamesmanship are legion.

Whether a Bankruptcy Court ruling is final or only proposed makes a big difference in the nature of later review. If the latter, the review is “de novo” meaning the District Court is free to reconsider the evidence as well as the law, instead of having to give deference to the factual findings of the Bankruptcy Court. Does this mean that all these cases can get automatically re-tried in the District Court? This has been so uncommon up to now that few of us know what to expect.

Arkison has opened the can of worms even more than before. We foresee that this is going to be a major headache for the entire federal court system. The Supreme Court has simply “kicked the can down the road” but the need for well-drawn lines and principles to guide courts and parties remains as urgent as ever. Until that happens, the prospect of dysfunction in many contested cases looms.

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