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Sixth Circuit Determines that Article III Prevents Parties From Consenting to Final Judgments by Ban

November 17, 2014 by Tyson A. Crist, Partner
In the ongoing fallout from the Supreme Court’s landmark bankruptcy decision in Stern v. Marshall, the Sixth Circuit Court of Appeals has become the first and only Circuit Court to decide that regardless of the consent or waiver of parties, there are certain types of claims that bankruptcy courts do not have constitutional authority to finally decide. This significant interpretation was issued on Oct. 26, 2012 in Waldman v. Stone, 698 F.3d 910 (6th Cir. 2012). Therein, the Sixth Circuit ruled that parties to a bankruptcy cannot waive the requirement under Article III of the Constitution—the separation of powers—that “private rights” claims be adjudicated by Article III courts. Thus, they cannot consent to bankruptcy courts entering final judgment on these claims.

As background, in June 2011, the Supreme Court of the United States decided Stern v. Marshall, or simply Stern, which held that bankruptcy judges who are appointed under Article I of the Constitution, not Article III, cannot enter final judgments on certain state law claims. This decision is one of only a handful of major bankruptcy decisions issued by the Supreme Court since 1978, when the current bankruptcy code was first enacted. Since Stern, the bankruptcy, district and appellate courts have been attempting to sort through and apply the Supreme Court’s constitutional analysis to almost every type of claim that can arise in a bankruptcy, including fraudulent transfer, preference and state law claims.

Waldman involved a state law claim filed by the debtor against his primary creditor, who had obtained the debtor’s business assets by fraud. It resulted in the bankruptcy court entering a $3 million judgment in favor of the debtor for compensatory and punitive damages. However, on appealthe Sixth Circuit applied the Supreme Court’s analysis in Stern and decided that the bankruptcy court’s judgment was unconstitutional because “the structural principle advanced by Article III” was at issue, which individuals cannot waive. Thus, they sent the case back to the bankruptcy court so that it could “recast its judgment” as a proposed ruling (proposed findings of fact and conclusions of law) to the district court, which is authorized by Article III of the Constitution to enter a final judgment. Upon review, however, the district court can “accept, reject, or modify” the proposed ruling of the bankruptcy court and can “receive further evidence, or recommit the matter to the bankruptcy judge with instructions.”

The types of claims that bankruptcy courts do not have authority to finally decide under Waldman include claims based on state law that solely seek to augment the debtor’s bankruptcy estate (to recover money for the estate). For example, the claim at issue in Waldman was the debtor’s state law fraud claim against his creditor. These are almost always claims that could have been brought outside of the bankruptcy. For ease of reference, these claims may be referred to as “Stern-type claims.”

Due to Waldman, unless and until it would be overruled, it will now likely be more expensive and time consuming for both debtors and creditors to litigate these Stern-type claims in the Sixth Circuit (Michigan, Ohio, Kentucky and Tennessee). Conversely, creditors and other defendants may have greater leverage in defending and negotiating resolutions of these claims. This is because a two-step process to obtain a final, enforceable judgment is now mandated and cannot be waived by the parties to save time and costs, as has been common practice under the prior presumption (and law of other Circuits) that parties could consent to the entry of final judgments by bankruptcy courts. This ruling by the Sixth Circuit may also provide litigants with a slightly stronger argument in some circumstances that these Stern-type claims should be heard by the district courts from the start, rather than in the bankruptcy courts. And Waldman may also provide a basis to argue that certain decisions of the bankruptcy courts are not final, enforceable judgments because they were unconstitutionally entered in violation of Article III.

The Stone case is a significant and somewhat troubling development in the ever-evolving interpretation of Stern because almost all courts to have considered this issue up until now had determined that litigants, post-Stern, could still consent to a final judgment by a bankruptcy court. Most courts believed that litigants could waive their rights, expressly or by conduct, under Article III of the Constitution to have these Stern-type claims entered by Article III courts—the district courts. Due to Waldman, however, parties might now be able to engage in the very “sandbagging”—waiting to challenge the constitutionality of a bankruptcy court’s judgment for the first time on appeal—that was chastised in the Stern decision itself. And Waldman could have even broader implications, if it is not overruled, because the authority for federal magistrate judges to issue final judgments under the Federal Magistrates Act is very similar to the current statutory authority upon which bankruptcy judges have statutory authority to issue final judgments with the consent of litigants.

For now at least, it appears the bankruptcy courts in the Sixth Circuit, when faced with Stern-type claims, can no longer enter final judgments against noncreditors to the bankruptcy, despite the consent of the parties. This includes claims based solely on state law, as in Stern, and, most likely, fraudulent conveyance claims under sections 544 and 548 of the Bankruptcy Code. If the Waldman case remains the law of the Sixth Circuit it will likely increase the workload of the district courts, as well as the time and costs to parties of obtaining final judgments.

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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