Tuesday, June 28, 2011

Thoughts About the Impact of Stern v. Marshall

Since the Supreme Court dropped its constitutional bombshell on the bankruptcy system last week in Stern v. Marshall, 2011 U.S. LEXIS 4791 (2011) (aka Anna Nicole Smith II), lots of people are scratching their heads and wondering what this all means. While Chief Justice Roberts suggested that the decision had only a "narrow" impact, many others, including myself, are not so sure. In this post, I am going to focus on the practical and theoretical impact of the decision.

The Practical Side

On the practical side, we are going to spend a whole lot more time fighting turf wars about whether a particular action belongs in bankruptcy court or somewhere else. That means even more motions to withdraw reference and motions to abstain. While Stern v. Marshall focused on the distinction between an Article III federal court and an Article I federal court, the more likely choice will be between an Article I federal court and a state court. While the Supreme Court was troubled by final decision making by judges who lacked life tenure and salary protection, the opinion may lead more cases to be decided by state court judges who lack these protections. One of the chief virtues that Chief Justice Roberts attributed to Article III judges was their freedom from outside influences. However, elected state court judges who must seek campaign contributions from the lawyers who appear in front of them and who are placed in office by an electorate that knows little more than their party affiliation seem to be the polar opposite. Thus, the theoretical and practical underpinnings of the opinion appear to be in tension.

A second practical effect will be delay. Bankruptcy Courts have proven to be efficient engines for deciding cases. In the Bankruptcy Court for the Western District of Texas, it is common for an adversary proceeding to go to trial within six months. In the U.S. District Court for the Western District of Texas, a civil action will take closer to two years to make it to trial. Bankruptcy Courts can proceed faster because they do not have a criminal docket which can trump civil actions and because they are not allowed to conduct jury trials.

The third practical effect will be that we will be fighting endless battles about finality. If the Bankruptcy Court rendered a final decision based on now-infirm core jurisdiction, can that decision be set aside under Rule 60? If an action is currently pending in Bankruptcy Court and the other party mistakenly admitted core jurisdiction, can they go back and change their mind? Can they file an untimely jury demand and move to withdraw the reference? I think the answer is likely no, but we will spend a lot of time arguing about it.

Theoretical Impact

On the intellectual side, we are going to spend more time thinking about what makes the bankruptcy system unique. In Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), Justice Brennan's plurality opinion referred to "the restructuring of debtor-creditor relations, which is at the core of the federal bankruptcy power." 458 U.S. at 71. We now know that that "core" is smaller than we thought it was. It seemed that resolving claims between the estate and persons filing claims against the estate would be intimately tied to "the restructuring of debtor-creditor relations." However, based on Stern v. Marshall, it appears to be limited to those functions which are both fundamental to the bankruptcy system and/or unique to the bankruptcy system. What are those functions?

To me, deciding claims is the least defensible of these functions because most claims objections revolve around whether a claim is allowable under state law. However, in his concurrence, Justice Scalia opined that determining claims might be permissible. Why is this? Justice Scalia cited a law review article that I haven't read which could likely provide a definitive answer. However, going out on a limb, I would suggest that determining claims is integral to what the Bankruptcy Court does because it is a necessary component of allocating scarce resources between creditors and the debtor. A State Court is concerned with a dispute between the debtor and one of his creditors. A Bankruptcy Court must deal with the debtor and potentially thousands of creditors. If one creditor gets too large of a slice of the pie, it means that everyone else gets less. State Court is all about the race to the courthouse, while Bankruptcy Court is about the collective resolution of claims. This collective aspect is what distinguishes the Bankruptcy Court.

What else is fundamental to or unique about the bankruptcy system? At a minimum, I would say: the automatic stay, the discharge, plans and the ability to use cash collateral, to sell assets free and clear of liens and to assume or reject executory contracts and unexpired leases. Each of these provisions is based on a specific Code-created right and does not exist outside of bankruptcy. Consider the automatic stay. It is true that injunctions exist outside of Bankruptcy Court. However, there is no comparable provision that allows for a universal injunction without proving a substantive right or posting security. Additionally, the automatic stay is fundamental to the bankruptcy process because it allows for the collective process to take place.

Exemptions pose an interesting question. Most exemptions in bankruptcy are determined by state law. State courts make decisions about exempt property all the time. However, I think exemptions are fundamental for two reasons. First, federal law can displace state law, as in the homestead caps contained in Sec. 522(o)-(q) and the ability to avoid liens under Sec. 522(f). Secondly, a State Court only rules upon an exemption dispute relating to a debtor and a creditor at a specific point in time. A Bankruptcy Court, on the other hand, determines the debtor's exempt property with respect to all of his creditors and draws a line in the sand saying this property is available for creditors and this property is the debtor's.

The distinction between preferences and fraudulent transfers raises another interesting question. Both preferences and fraudulent transfers are Code-created rights. However, in Granfinanciera v. Nordberg, 492 U.S. 33 (1989), the Supreme Court held that fraudulent transfers did not involve "public rights." Is there a distinction between them? One distinction is that fraudulent transfer law exists outside of bankruptcy, while preference law does not. A preference is defined by the fact that it occurred on the eve of bankruptcy, while a fraudulent transfer can happen at any time. A fraudulent transfer action recovers property rightfully belonging to the debtor, while a preference action is designed to provide equality of distribution between creditors (and make money for trustee's lawyers).

In defining the new boundaries of core jurisdiction, I think it is important to ask three questions:

1. Does it involve a Code-created right?
2. Does it exist outside of bankruptcy?
3. Does it have a collective aspect to it?

I predict that an action that satisfies two out of three of these tests will be a core proceeding 99% of the time.


Anonymous said...

Excellent analysis, especially regarding the theoretical tensions with having state courts decide more adversary proceedings.

Minor quibble: Bankruptcy courts are allowed to conduct jury trials.

Anonymous said...

Why doesn't Congress just make the bankruptcy courts Article III courts? Just make them Article III district courts with jurisdiction limited to bankruptcy cases and matters arising under title 11 and matters arising in cases under title 11.

I guess that would be PROgress and not CONgress.

Ron Satija said...

Thanks Steve. Looking forward to your July 12 webinar.

Illana Behrend Stuppel said...

Do you have any thoughts about the impact this may have on a bankruptcy proceeding involving debtor's assets also implicated in community assets, in a pending divorce proceeding? Or visa verse?

Unknown said...

Do you have any thoughts about the impact this may have on a bankruptcy proceeding involving debtor's assets also implicated in community assets, in a pending divorce proceeding? Or visa verse?

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