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Stern Now Acknowledged to Weigh in Favor of Withdrawing Cases from Bankruptcy Court

November 10, 2014 by Tyson A. Crist, Partner
Stern Now Acknowledged to Weigh in Favor of Withdrawing Cases from Bankruptcy Court

In two recent decisions, district courts have now acknowledged that the Supreme Court’s decision in Stern v. Marshall[i] must be factored in when deciding whether to leave an adversary proceeding in bankruptcy court—whether to withdraw the reference.  In short, when a bankruptcy court lacks constitutional authority to enter a final judgment, the resultant delay, waste of judicial resources and increased costs to the parties weigh in favor of withdrawing the reference.  These factors could still be outweighed by other facts and circumstances in a particular case, but at least this is now a legitimate arrow in the quiver of would-be defendants sued for fraudulent transfers or on purely state law claims—Stern type claims.
In the first case the issue was whether the reference should be withdrawn because the bankruptcy court lacked constitutional authority to decide a fraudulent transfer action.  Emerson v. Treinish, No. 1:13-mc-52, 2014 WL 2807481 (N.D. Ohio June 20, 2014).  The chapter 7 trustee sued the debtor’s wife to recover fraudulent transfers.  She moved for withdrawal of the reference, but the district court stayed the case pending the Supreme Court’s decision in Arkison.[ii]
Following the issuance of Arkison, the district court held that, similar to Arkison, this case involved fraudulent conveyance claims against a noncreditor.  Under the procedure outlined in Arkison, the bankruptcy court could keep the case and issue proposed findings of fact and conclusions of law for review by the district court.  The district court also noted that neither Stern nor Arkison had deprived bankruptcy courts of the authority to handle pre-trial supervision of cases.  Nevertheless, the district court found that it should permissively withdraw the reference because the defendant had exercised her right to a jury trial and did not consent to the jurisdiction of the bankruptcy court under 28 U.S.C. § 157(e).  These factors, combined with judicial economy and preserving the parties’ resources, all weighed in favor of withdrawing the reference.
The second and more recent case involved a liquidating trust’s post-confirmation assertion of a “prototypical Stern claim”—a state law counterclaim deemed statutorily “core” only because the defendant, mortgage originator had filed a proof of claim.  ResCap Liquidating Trust v. PHH Mortgage Corp., No. 14 Cv. 05315 (JGK), 2014 WL 5068339 (S.D.N.Y. Oct. 9, 2014). Prior to confirmation of the liquidating plan the debtor had asserted the same action in Minnesota (along with 60 others), rather than New York, where the bankruptcy was filed.  Further, the relevant agreement contained a mandatory Minnesota forum-selection clause, and the Minnesota District Court had already resolved numerous actions involving nearly identical contract disputes.
In analyzing the withdrawal of reference test established pre-Stern by the Second Circuit Court of Appeals, the district court noted it should be modified to include consideration of whether the bankruptcy court could constitutionally enter a final judgment.  Accordingly, in this case in which a number of factors weighed in favor of withdrawing the reference, the bankruptcy court’s inability to issue a final judgment tipped the scales:  “That the bankruptcy court cannot issue a final judgment on ResCap’s counterclaim supports withdrawing the reference.”  Id., at *5.
Notably, in reaching its conclusion the district court characterized Arkison as holding that “referring a ‘Stern claim’ to the bankruptcy court may increase delay, waste judicial resources, and heighten the parties’ costs.”  Id., at *5 (citing Arkison, 134 S. Ct. at 2168, 2173 (2014)).  In this circumstance, the district court found that leaving the counterclaims in the bankruptcy court would result in all the ills identified in the Arkison case and that “[k]eeping this case in the bankruptcy court would also promote forum shopping.”  Id. *5–6.  In contrast, “withdrawing the counterclaims would prevent duplicative work.”  Id. (citing several similar recent decisions); but see Residential Funding Co. v. Greenpoint Mortg. Funding, Inc. (In re Residential Capital Co.), No. 14cv5452, slip op. at 20 (S.D.N.Y. Sept. 24, 2014) (involving a New York forum-selection clause).
The takeaway for companies and individuals sued in bankruptcy court on fraudulent transfer or purely state law based claims is that the strategy of moving to withdraw the reference has been enhanced by Stern and can work to ultimately reduce delay and costs.  However, because of the numerous factors considered on a case-by-case basis in a withdrawal of reference analysis, this will not work in every case.
[i]       131 S. Ct. 2594 (2011).
[ii]       Exec. Benefits Ins. Agency v. Arkison, 134 S. Ct. 2165 (2014).

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