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Stern Has Nothing to Do with Subject Matter Jurisdiction — The Real Limits of Bankruptcy Court Juris

November 13, 2014 by Tyson A. Crist, Partner
Much has been written about the U.S. Supreme Court’s decision in Stern v. Marshall and its fallout in the bankruptcy, district and appellate courts. In the first installment of our Bankruptcy & Financial Restructuring E-Alert issued on Jan. 7, 2013, I wrote about two such appellate decisions in the 6th and 9th Circuit courts – Waldman v. Stone (read the article here) and Executive Benefits Insurance Agency v. Arkison (In re: Bellingham Insurance Agency, Inc.) (read the article here). However much the Stern decision may have shaken up the bankruptcy world, one thing is clear: it has nothing to do with the subject matter jurisdiction of the bankruptcy courts.

Faced with defending a claim brought in bankruptcy court, defense counsel may think of Stern and wonder whether it may be the basis for a motion to dismiss under Rule 12(b)(1) – lack of subject matter jurisdiction. However, with the benefit of canvassing nearly a year’s worth of post-Stern case law on this issue, one finds that the unanimous response of the courts is that Stern is not the answer, because it had nothing to do with the subject matter jurisdiction of bankruptcy courts. “This is because ‘Stern dealt with whether a bankruptcy court may determine, i.e. enter a final order, rather than whether a bankruptcy court may hear, i.e. has subject matter jurisdiction over, a proceeding.’ ”As a result, “a motion to dismiss a proceeding for lack of subject matter jurisdiction based solely on Stern is destined to fail.”

Despite all the consternation about Stern, bankruptcy courts can continue to hear any claims over which they have at least the minimum “related to” jurisdiction under 28 U.S.C. § 1334(b), just as they did before the Stern. Whether a bankruptcy court can enter a final judgment post-Stern is a separate issue that does not impact its jurisdiction. In other words, the true limit, or outer bounds, of bankruptcy court jurisdiction is still the “related to” category of claims.

The boundary of bankruptcy court jurisdiction was recently examined by Judge Humphrey of the U. S. Bankruptcy Court for the Southern District of Ohio, Western Division at Dayton in Johnston v. City of Middletown (In re Johnston). As noted by Judge Humphrey, “ ‘[t]he jurisdiction of the bankruptcy courts, like that of other federal courts, is grounded in, and limited by, statute.’” And in bankruptcy court the statute of jurisdiction is 28 U.S.C. § 1334, under which district courts almost always refer matters to the bankruptcy courts under 28 U.S.C. § 157(a) and general orders of reference.

When a civil (adversary) proceeding is filed in a bankruptcy case, the bankruptcy court must examine its jurisdiction to hear the claims asserted. The minimum threshold is that the “ ‘matter is at least ‘related to’ the bankruptcy.’” A matter is “related to” a bankruptcy case if “ ‘the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy.’” At the same time, there may be proceedings that are so tenuously connected to the bankruptcy case that they would not fit within this “related to” jurisdiction.

In the Johnston case before Judge Humphrey, the primary issue was whether the court had jurisdiction to hear the debtor’s complaint against the Internal Revenue Services and the city of Middletown, Ohio, for a declaratory judgment that he was not personally responsible under state and federal law for employment (trust fund) taxes owed by three corporate entities that he owned. However, his chapter 7 bankruptcy was a “no asset case” in which creditors would not receive any distribution from the estate. Thus, Judge Humphrey took this case as an opportunity to determine whether this type of recurring claim fits within the bankruptcy court’s “related to” subject matter jurisdiction. And he held it does not – bankruptcy courts do not have jurisdiction “to make a responsible person determination as to debtors in no-asset [c]hapter 7 cases.” The reasoning for this holding was that “while the outcome could most definitely alter the debtor’s liabilities, rendering of the responsible person determination does not have any conceivable effect on the estate being administered – it does not affect property of the estate and does not affect distributions to creditors or otherwise affect the administration of this bankruptcy estate except for delaying the closing of the case until the . . . adversary proceeding[] is concluded.”

While a no-asset chapter 7 responsible person determination is a relatively unique circumstance for which only individuals and government entities need be concerned, the broader point of the ruling in Johnston, and that Stern has nothing to do with subject matter jurisdiction, is salient for all defendants to adversary proceedings brought in bankruptcy cases. To the extent that a claim will ultimately have no conceivable effect on the bankruptcy estate, whether it be in a chapter 7, 11 or 13 case, there may well be grounds to move to dismiss that claim for lack of subject matter jurisdiction in the bankruptcy court under Rule 12(b)(1) because it is beyond the “related to” outer bounds of the court’s jurisdiction under 28 U.S.C. § 1334. Conversely, attempting to obtain dismissal of an adversary proceeding based solely on Stern is a fool’s errand that will result in costs and expenses that do not further the defendant’s end goal. Of course, this is a case-by-case determination, but one worthy of note for those needing to defend themselves from claims brought by a debtor or trustee in a bankruptcy.

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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