Source: https://www.tkinsolvencyblog.com/2012/03/index.html
Timestamp: 2019-04-21 04:09:01+00:00

Document:
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 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.
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.
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?
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.
Has the Fifth Circuit tipped its hand re: Stern v. Marshall?
On March 5, 2012, in Technical Automation, the Fifth Circuit sua sponte raised the issue of whether a magistrate judge had authority to enter a final judgment post-Stern on state-law claims. The statute pursuant to which the Magistrate Judge rendered final judgment, section 636(c), is similar to 157(b), except insofar that the parties must consent to the magistrate's entry of final judgment.
Although recognizing the "similarities between bankruptcy judges and magistrate judges suggest that the Court's analysis in Stern could be extended to this case," a pre-existing Fifth Circuit case held that magistrates could enter final judgments on section 636(c). Because Stern did not expressly overrule such prior Fifth Circuit case law, the Fifth Circuit held that until the en banc Fifth Circuit or the Supreme Court holds otherwise, magistrates in the Fifth Circuit have authority to enter final judgments on state-law claims as long as the parties consent. The consent element in section 636(c) is similar to the consent element in section 157(c), which allows a bankruptcy court to enter final judgments in non-core proceedings with the consent of the parties.
Combined with the Fifth Circuit's emphasis in Technical Automation that the issue addressed in Stern is a "narrow one" that related only to "certain counterclaims in bankruptcy," the take away is that the Fifth Circuit seems to have "cracked the door open" to any interested appellants to see just how narrow the Fifth Circuit will apply Stern. An interesting issue is whether the Fifth Circuit would apply the same analysis and hold that with the parties' consent and the narrow nature of Stern, a bankruptcy court may enter a final judgment on a state law claim under section 157(c).

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