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Ninth Circuit Determines Article III Bars Bankruptcy Courts From Entering Final Judgments on Fraudul

November 14, 2014 by Tyson A. Crist, Partner
Ninth Circuit Determines Article III Bars Bankruptcy Courts From Entering Final Judgments on Fraudulent Transfer Claims: Bellingham Insurance Agency, Inc. 

The Ninth Circuit Court of Appeals recently issued a long-awaited and much-anticipated decision applying the United States Supreme Court’s landmark ruling in Stern v. Marshall to fraudulent transfer claims. The main issue before the Ninth Circuit in Executive Benefits Insurance Agency v. Arkison (In re: Bellingham Insurance Agency, Inc.), ___ F.3d ___, No. 11-35162 (9th Cir. Dec. 4, 2012), for which it invited supplemental amicus curiae briefs, was whether Stern prohibits bankruptcy courts from continuing to enter final, binding judgments on claims to avoid fraudulent conveyances, brought under sections 544 and 548 of the Bankruptcy Code. These claims are often brought by chapter 7 trustees and chapter 11 liquidating trustees to recover assets for the benefit of creditors. As most district courts have already found (contrary to many bankruptcy courts), the Ninth Circuit is the first Court of Appeals to determine, subject to a couple notable exceptions, that Article III of the Constitution “bars bankruptcy courts from entering final judgments” on fraudulent conveyance claims.

The key reason for the Ninth Circuit’s conclusion was that the defendant, the party accused of receiving the fraudulent transfer, was not a creditor to the bankruptcy such that the fraudulent transfer claim could not be resolved within the context of adjudicating a claim against the bankruptcy estate. This is the first possible exception to the constitutional bar established by Stern that would enable a bankruptcy court to enter a final judgment, and it is the factor that distinguishes this decision from the Sixth Circuit Court of Appeals’ recent opinion in Onkyo Europe Electronics GMBH v. Global Technovations Inc. (In re Global Technovations Inc.), 694 F.3d 705 (6th Cir. 2012). Therein, the Sixth Circuit found it was “crystal clear” that a bankruptcy court could constitutionally enter a final judgment on a fraudulent transfer claim under Stern “because it was not rule on [the creditor’s] proof of claim without first resolving the fraudulent-transfer issue.”

The Ninth Circuit ultimately ruled that the bankruptcy court in Bellingham could enter a final judgment because of a second exception to the constitutional bar under Stern; that the defendant had waived its right to have the final judgment entered by an Article III court—by the district court. In other words, the defendant consented to the bankruptcy court’s entry of a final judgment. Notably, the defendant in Bellingham, similar to the defendant in Waldman v. Stone, 698 F.3d 910 (6th Cir. 2012), did not challenge the constitutionality of the bankruptcy court’s ability to enter a final judgment until it appealed to the Circuit Court. However, as opposed to the outcome in Waldman, the Ninth Circuit adhered to Stern and other precedents to determine that the right to have a judgment entered by an Article III court can be waived because “the consequences of a litigant sandbagging the court—remaining silent about his objection and belatedly raising the error only if the case does not conclude in his favor—can be...severe.” The Ninth Circuit noted that this conclusion is consistent with the constitutional power of federal magistrate judges to enter final judgments on Article III common law claims under 28 U.S.C. § 636 when parties consent, either expressly or as implied by conduct—by waiver.

Notably, this opinion puts the Ninth and Sixth Circuit Court of Appeals squarely at odds over the issue of whether parties may consent to the entry of a final judgment by a bankruptcy court. The Sixth Circuit found in Waldman that parties cannot waive the separation of powers under Article III due to the dual nature of the Article III protections, which are both for the protection of individuals’ rights as well as structural integrity of our constitutional system. Interestingly, even though the Ninth Circuit cited the Waldman decision in Bellingham in respect to another issue, and was obviously aware of its existence, the Ninth Circuit chose not to discuss or distinguish the Sixth Circuit's ruling on the consent issue.

The fundamental analysis in Bellingham was whether a fraudulent conveyance claim asserted in a bankruptcy is a “public” or a “private” right. There are only three exceptions to Article III, one of which is the “public rights” exception, the only exception that can apply to claims arising in a bankruptcy. If a claim fits within this exception then it may be withdrawn from the otherwise exclusive domain of Article III courts, notwithstanding the constitutional separation of powers, and it may be delegated by Congress to legislative courts, such as bankruptcy courts, for final adjudication. Conversely, claims that are “private rights”—claims that are based on common law, for which parties are often entitled to jury trials under the Seventh Amendment to the Constitution—must ultimately be decided by Article III courts, although they can still be heard and determined by bankruptcy courts, which then make recommendations for the final judgment to the district courts. Fundamentally, the “public rights” exception for bankruptcy encompasses the “restructuring of debtor-creditor relations,” but not the “adjudication of state-created private rights.”

Because the Stern decision equated fraudulent transfer claims to the state law claims at issue therein, the Ninth Circuit concluded that bankruptcy courts do not have constitutional authority to enter final judgments on fraudulent conveyance claims “asserted against noncreditors to the bankruptcy estate” in the absence of consent by the parties. Instead, the Ninth Circuit found, borrowing the language of Stern, that fraudulent conveyance actions “are quintessentially suits at common law that more nearly resemble state-law contract claims brought by a bankrupt corporation to augment the bankruptcy estate than they do creditors’ hierarchically ordered claims to a pro rata share of the bankruptcy res.” Thus, the Ninth Circuit determined that “following the Supreme Court’s judgment in Stern v. Marshall, the view that such judgments [by bankruptcy courts in fraudulent conveyance actions] are consistent with the Constitution is no longer tenable.”

Additionally, the Ninth Circuit determined that even though Stern created a gap in the statute that specifies the types of claims for which bankruptcy courts may hear and then submit proposed findings of fact and conclusions of law to the district courts, bankruptcy courts may continue to do so for fraudulent conveyance claims. Because such claims are deemed “core” under 28 U.S.C. § 157(b)(2)(H), but § 157(c)(1) only expressly authorizes bankruptcy courts to submit proposed findings of fact and conclusions of law on “non-core” claims, some had argued that the Stern decision rendered “bankruptcy courts impotent to address fraudulent conveyance proceedings, because they fall in the interstices of § 157[.]” But the Ninth Circuit reasoned that because Stern only abrogates the power of bankruptcy courts to enter final judgments on private rights claims and does not affect their power to hear and determine all claims within their statutory jurisdiction, both private and public, bankruptcy courts can continue to hear fraudulent conveyance claims and make recommendations for final judgments to the district courts.

Much like the state law claims at issue in both Stern and Waldman, bankruptcy courts in the Ninth Circuit now cannot enter final judgments on fraudulent conveyance claims unless: (a) the defendant is a creditor and the defendant’s claim against the debtor will necessarily be resolved in ruling on the fraudulent conveyance claim; or (b) the parties consent, expressly or as implied by waiver.

The Bellingham decision represents a growing trend of courts to interpret Stern beyond its professedly limited holding to further limit the types of claims on which bankruptcy courts can constitutionally enter final, binding judgments, notwithstanding the types of claims deemed “core” by Congress in 28 U.S.C. § 157. A question implicated by, but not discussed in the Bellingham decision is whether bankruptcy courts have constitutional authority under Stern to enter final judgments on claims to avoid preferential transfers (also deemed “core” by Congress) against parties that are not creditors to a bankruptcy and that do not consent. This is likely to be one of the next key developments in the case law applying Stern.

For more information, contact Tyson Crist at (614) 462-2243 or or any member of Ice Miller's Bankruptcy and Financial Restructuring Group.

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