Stern v. Marshall: The Texas Cases

This is a paper that I did for the Austin Bar Association summarizing the Texas cases applying Stern v. Marshall to date.   Please note that where the holding is indented, I am directly quoting the opinion.   I also used the following key for highlighting certain decisions:

*--If you only read a few cases, read these ones.

#--Cases where the Court found that Bankruptcy Judge lacked authority to enter a final order. 

Fifth Circuit Court of Appeals:

Technical Automation Services Corp. v. Liberty Surplus Insurance Corporation, 673 F.3d 399 (5^th Cir. 3/5/12)(E. Grady Jolly)

Facts:              Magistrate Judge granted summary judgment on an insurance coverage dispute.   Fifth Circuit sua sponte requested briefing on whether Stern v. Marshall affected the Magistrate Judge’s ability to enter a final judgment.

Holding:          Stern v. Marshall did not overrule prior precedent on constitutionality of U.S. Magistrate’s authority to enter a final judgment.

U.S. District Courts:

Feuerbacher v. Moser, 2012 U.S. Dist. LEXIS 44396 (E.D. Tex. 3/29/12)(Marcia A. Crone)

Facts:  Trustee sued debtor’s husband under TUFTA to recover fraudulent transfers.    Bankruptcy Court ruled in favor of Trustee.   On appeal, husband raised a Stern issue.

Holding:

           

Application of the aforementioned rationales to the case at bar reveals that Stern does not preclude the bankruptcy court from issuing a final judgment on claims where, as here, the Trustee seeks to recover fraudulent transfers.  

Mahanna v. Bynum, 465 B.R. 436 (W.D. Tex. 11/28/11)(Sam Sparks)

           

Facts:  Debtors filed chapter 13 bankruptcy.   Court directed debtors to convert to chapter 7 or chapter 11.   Debtors converted to chapter 11.   After debtors failed to comply with obligations of debtors-in-possession, U.S. Trustee filed Motion to Dismiss or Convert.    Debtors requested conversion.   Court dismissed the case over debtors’ objection.   Debtors appealed.

           

Holding:   Court rejected argument that Bankruptcy Court lacked authority to enter a final order on motion to dismiss or convert.

 

Stern did not destroy all finality in bankruptcy courts, it simply held § 157(b)(2)(C) was unconstitutional to the extent it swept counterclaims not arising in or under Title 11 into the category of "core" proceedings.

Bushman v. Moore, 2011 U.S. Dist. LEXIS 154776 (S.D. Tex. 9/14/11)(Vanessa D. Gilmore)

           

Facts:  Bankruptcy Court entered judgment finding debt to be non-dischargeable and finding that property was not homestead.

           

Holding:  Debtors argued that Stern v. Marshall prevented Bankruptcy Court from entering final judgment.  

Here, in contrast to Stern v. Marshall, the Bankruptcy Court was not ruling on a state law counterclaim, but on a determination as to the dischargeability of particular debts under 28 U.S.C. § 157(b)(2)(I). These types of claims remain under the bankruptcy judge's core proceedings jurisdiction following Stern v. Marshall.

           

#In re AIH Acquisitions, LLC, 2011 U.S. Dist. LEXIS 101190 (N.D. Tex. 9/7/11)(John McBryde)

Facts:  Individuals filed plea in intervention in adversary proceeding involving Textron.   Bankruptcy Court dismissed claims with prejudice for failure to plead with specificity under Rule 9(b)).

Holding:          Bankruptcy Court lacked authority to enter a final order on claims.    Claims asserted in plea in intervention were state law claims similar to the counterclaim in Stern v. Marshall.   The District Court reversed the dismissal order and withdrew the reference.

Bankruptcy Courts:

Burchik v. Butler, Adv. No. 11-1220 (Bankr. W.D. Tex. 5/10/12)(Craig A. Gargotta)(oral ruling)

            Facts:  Chapter 7 Debtor brought suit against former counsel for malpractice.

            Holding:          In announcing oral ruling, Court noted that absent consent, it would not have had authority to enter a final ruling under Stern.   Because parties expressly consented, Court could enter a final order.

In re Ruth, 2012 Bankr. LEXIS 1857 (Bankr. S.D. Tex. 4/26/12)(Jeff Bohm)

           

Facts:  Debtors filed adversary proceeding against creditor seeking to deny claim and recover sanctions for abuse of the proof of claim process and for vexatious litigation.

           

Holding:  Court had authority to enter a final order on counterclaim to proof of claim because counterclaim arose out of Bankruptcy Code and Bankruptcy Rules.  Additionally, it was necessary to resolve the dispute to determine the claim.

In re Bechuck, 2012 Bankr. LEXIS 1459 (Bankr. S.D. Tex. 4/4/12)(Jeff Bohm)

           

Facts:  Trustee filed an application to employ special counsel.

           

Holding:   Because Court denied application to employ special counsel, authority to enter a final order was not implicated.    However, Bankruptcy Court would nevertheless have authority because employment of counsel is governed by Bankruptcy Code and Bankruptcy Rules.

In re Laughlin, 2012 Bankr. LEXIS 1268 (Bankr. S.D. Tex. 3/23/12)(Jeff Bohm)

           

Facts:  Creditor filed complaint to determine dischargeability of debt.

           

Holding:         

This suit is therefore based on an express bankruptcy statute; indeed, the requested relief is unique to the Code and could never be obtained under state law. For these reasons alone, this Court concludes that Stern is inapposite, and therefore it has constitutional authority to enter a final judgment in this dispute.

In re Thalmann, 2012 Bankr. LEXIS 1066 (Bankr. S.D. Tex. 3/13/12)(Jeff Bohm)

           

Facts:  Creditor moved to dismiss case as having been filed in bad faith and Debtor objected to proof of claim filed by State Court Receiver.

           

Holding:         

State law has no equivalent to (sections 1307(c) and 1325(a)(3) and (a)(7)); they are purely a creature of the Bankruptcy Code. Accordingly, because the resolution of this dispute is based on express bankruptcy statutes, not state law, Stern is inapplicable, and this Court has the constitutional authority to enter a final judgment on the Motion pursuant to 28 U.S.C. §§ 157(a) and (b)(1).

In re Carlew, 2012 Bankr. LEXIS 1006 (Bankr. S.D. Tex. 3/9/12)(Jeff Bohm)

           

Facts:  Chapter 7 trustee objected to debtor’s exemptions.

           

Holding:         

In the dispute at bar, the Chapter 7 Trustee has objected to the Debtor's exemption of the Insurance Proceeds pursuant to Section 522(l) and Fed. Bankr. R. 4003(b). State law has no equivalent to this statute and rule; therefore, the facts in this case  are distinguishable from those in Stern, which involved solely state law. Granted, the resolution of the dispute at bar does hinge on Texas state law regarding homestead exemption. But, unlike Stern, where the resolution of the debtor's counterclaim did not necessarily adjudicate the creditor's claim, here, the resolution will certainly determine whether the Debtor has a claim to the Insurance Proceeds. If he does--i.e. if these proceeds are exempt--there will necessarily be less funds available for distribution for creditors. If the Debtor does not have a claim to the Insurance Proceeds--i.e. the proceeds are not exempt--then the Trustee will have more funds to distribute the proceeds to pay creditors. For these reasons, the dispute at bar is sufficiently distinguishable from the dispute in Stern for this Court to sign a final order.

In re Frazer, 466 B.R. 107 (Bankr. S.D. Tex. 107 (Bankr. S.D. Tex. 3/5/12)(Jeff Bohm)

            Facts:  Debtors filed adversary proceeding to strip lien of homeowners association from their homestead.

            Holding:  While validity of lien depends on state law, determination of dispute is necessary to resolve claim and therefore Court has authority to enter a final order.

In re Crescent Resources, LLC, 2012 Bankr. LEXIS 843 (Bankr. W.D. Tex. 3/2/12)(Craig A. Gargotta)

            Facts:  Plan Trustee filed a Complaint to Avoid and  Recover Improper “Bonus” Payments.    Defendants filed a Motion to Dismiss.    Court granted motion in part and denied in part.    Specifically, Court ruled that plan of reorganization did not adequately preserve causes of action under 11 U.S.C. §544 under state fraudulent conveyance law.  Trustee requested that Court certify a direct appeal to the Fifth Circuit Court of Appeals.   One issue that the Trust requested the Court to certify was whether the Court had authority to enter a final order dismissing the claims with prejudice.

            Holding:          Court disagreed that case was “squarely within the category of state law proceedings” implicated by Stern.    Although case involved a fraudulent transfer action brought under state law by virtue of strong arm powers under section 544, Court’s ruling was based upon interpretation of the Plan.    Furthermore, order was interlocutory and therefore was not a “final” order governed by Stern.

*In re American Housing Foundation, 2012 Bankr. LEXIS 449 (Bankr. N.D. Tex. 2/10/12)(Robert Jones)

            Facts:  Trustee brought actions under 11 U.S.C. §§544, 547 and 548.   96 defendants in 20 adversary proceedings filed motions to dismiss based on Stern v. Marshall.   Motions were filed under Rule 7012(b)(1) based on lack of subject matter jurisdiction.

            Holding:          Court assumed that it did not have authority to enter final orders in proceedings because defendants did not file claims and causes of action did not fit within public rights doctrine.    Court considered whether it could hear cases and issue proposed findings of fact and conclusions of law to the U.S. District Court.  “(I)t makes little sense to suggest that a bankruptcy judge has authority to hear a matter and issue proposed findings of fact and conclusions of law on "related to" matters but does not have authority to do the same with respect to "core" matters.”   Court concluded that it could enter non-binding findings of fact and conclusions of law.    Case contains a very thoughtful and extensive discussion of Stern.  

In re Franceschini, 2012 Bankr. LEXIS 156 (Bankr. S.D. Tex. 1/12/12)(Marvin Isgur)

           Facts:  Creditor brought action to determine dischargeability under 11 U.S.C. §523(a)(6).

            Holding:         

The right to a discharge is established by the Bankruptcy Code and is central to the public bankruptcy scheme.   (citations omitted).   Determinations of whether a debtor meets the conditions for a discharge are integral to the bankruptcy scheme, and bankruptcy courts have the authority to make such determinations pursuant to its in rem jurisdiction. (citation omitted).”   Court had authority to enter final order on determination of dischargeability.

In re Hereford Biofuels, LP, 2012 Bankr. LEXIS 22 (Bankr. N.D. Tex. 1/3/12)(Stacey C.G. Jernigan)

            Facts:  Non-debtor brought action against another non-debtor over interpretation of section 363 order.

      Holding:  

       

While the Adversary Proceeding has arisen in a post-confirmation context, and is between two non-debtor parties, the disputes herein ultimately concern: (a) the interpretation and enforcement of a prior sale order of the bankruptcy court, under section 363 of the Bankruptcy Code (and the asset purchase agreement that the bankruptcy court approved); and (b) the definition of what was or was not property of the bankruptcy estate in the underlying bankruptcy case, pursuant to section 541 of the Bankruptcy Code. In fact, the asset purchase agreement, the bankruptcy court sale order, and what was "property of the estate," are undoubtedly at the crux of the parties' disputes. The only place that one would find a bankruptcy court sale order and these post-sale issues is in the context of a bankruptcy case. Thus, the court determines that this is a core "arising  in" proceeding, pursuant to 28 U.S.C. §§ 157(b)(2)(A), (O) & 1334(b). It is a proceeding in which the bankruptcy court may enter final orders.

In re Hill, 2011 Bankr. LEXIS 5186 (Bankr. S.D. Tex. 12/30/11)(Jeff Bohm)

            Facts:  Chapter 13 trustee filed objection to exemptions and motion to modify confirmed plan.

            Holding:          Because proceeding arose under Bankruptcy Code and Rules, Court could enter a final order.   Public rights doctrine applied as well.

 

*In re Apex Long Term Acute Care-Katy, LP, 465 B.R. 452 (Bankr. S.D. Tex. 12/28/11)(Marvin Isgur)

            Facts:  Trustee brought four preference suits.   Trustee compromised three of the cases and sought to dismiss them with prejudice.  Trustee sought a default judgment on the fourth case. 

            Holding:  Court raised issue of its ability to enter the orders sua sponte.   Because dismissal with prejudice and default judgment constitute final orders, Court had to examine its authority.   After extensive analysis, Court concluded that it could enter final orders in cases where defendants filed claims because preference action was part of the claims adjudication process.    As to defendants who did not file claims, Court could enter final orders based on the public rights doctrine.”   Thia is a very scholarly opinion and should be the "go to" opinion for defending the ability of the bankruptcy court to enter final orders in a preference case.

 

In re Carroll, 464 B.R. 293 (Bankr. N.D. Tex. 12/13/11)(Barbara J. Houser)

            Facts:  Debtor filed for chapter 13 relief.   Creditor sought to liquidate claims and have them declared to be nondischargeable.    Debtor argued that court did not have jurisdiction.

            Holding:          Court had authority to enter final orders.   Stern clarifies “bankruptcy courts’ constitutional power, not their subject matter jurisdiction.”   “(T)here can be little doubt that this Court, as an Article I tribunal, has the Constitutional authority to hear and finally determine what claims are non-dischargeable in a bankruptcy case. Determining the scope of the debtor's discharge is a fundamental part of the bankruptcy process.”   Because Stern left intact Court’s ability to adjudicate a creditor’s claim, Court may liquidate amount of non-dischargeable debt.

*#In re Soporex, Inc., 463 B.R. 344 (Bankr. N.D. Tex. 11/28/11)(Barbara J. Houser)

            Facts:  Trustee filed complaint against officers and directors for breach of fiduciary duty and objections to claim.   Defendants filed motion to dismiss which did not raise a Stern issue.

            Holding:          Court raised Stern issue sua sponte.   Court concluded that it could not enter a final order on trustee’s counterclaims against insiders filing claims.    Court ruled that it could issue proposed findings and conclusions to the district court on statutory core proceedings where it lacked constitutional authority to enter a final order.   In dicta, Court noted whether parties could “remove the constitutional impediment identified by Stern by consent is unclear.”

Many are debating the breadth of the Supreme Court's decision in Stern. The arguments are interesting and, in some instances, mind-numbing. For today, I leave those arguments to others because I believe that the issue before me can be more simply, and practically, decided. It would be incredibly ironic for this Court to lack constitutional authority to finally determine the Trustee's breach of fiduciary duty and corporate waste claims against Smith and Sabolik (when they actually inserted themselves into Inc.'s bankruptcy case by filing a proof of claim) as the Supreme Court has clearly held in Stern, but to have constitutional authority to finally determine the Trustee's breach of fiduciary duty claims (arising from substantially the same acts or failures to act) against Linehan, the Outside Directors, and Letson, who chose not to involve themselves in the Debtors' bankruptcy cases at all until they were forced to do so by the Trustee's decision to sue them here. As a practical matter, this Court concludes that such a result is irreconcilable with the Supreme Court's analysis in Stern. If this Court lacks constitutional authority to finally determine  one set of breach of fiduciary duty claims against two former officers of certain of the Debtors, surely it lacks constitutional authority to finally determine substantially identical sets of breach of fiduciary duty claims against other former officers and/or directors of certain of the Debtors.

            As a result, the Court submitted proposed findings of fact and conclusions of law with regard to the motions to dismiss.

In re Whitley, 2011 Bankr. LEXIS 4545 (Bankr. S.D. Tex. 11/21/11)(Jeff Bohm)

            Facts:  Court issued order to show cause regarding compensation of attorney in chapter 13 proceedings.

            Holding:         

The dispute at bar is not a counterclaim of the Debtor, nor does it arise out of state law; therefore, Stern does not apply. This suit arises out of alleged violations of the disclosure requirements imposed by an express Bankruptcy Code provision--i.e. § 329. Moreover, the Trustee also seeks relief based upon another express Bankruptcy Code provision--i.e. § 330, which allows the Court to award or deny compensation to attorneys that represent the debtor and the debtor's estate. State law has no equivalent to these statutes; they are purely creatures of the Bankruptcy Code. Accordingly, the resolution of this dispute is not based on state common law, Stern does not apply, and this Court has the constitutional authority to enter a final judgment in this dispute pursuant to 28 U.S.C. §§ 157(a) and (b)(1).

In re Chao, 2011 Bankr. LEXIS 4543 (Bankr. S.D. Tex. 11/21/11)(Jeff Bohm)

            Facts:  Court issued Memorandum Opinion Regarding Sua Sponte Conversion of Case from Chapter 11 to Chapter 7.

            Holding:          Court found that it had authority to enter a final order converting the case from chapter 11 to chapter 7.

#In re Special Value Continuation Partners, LP,  2011 Bankr. LEXIS 4475 (Bankr. S.D. Tex. 11/15/11)(Marvin Isgur)

            Facts:  Lenders filed a state court action against officers and directors alleging that they provided misleading financial projections and made misrepresentations to obtain financing for company which filed bankruptcy.   Defendants removed case and requested that venue be transferred to Delaware.   Plaintiffs moved to abstain and remand.

            Holding:          One factor that court considered in denying motion to transfer venue and granting motions to abstain and remand was that court could not enter a final order under Stern.   “These are state law causes of action by nondebtors against nondebtors. The causes of action neither derive from nor depend upon any agency regulatory scheme.”

In re Noram Resources, Inc., 2011 Bankr. LEXIS 4268 (Bankr. S.D. Tex. 11/7/11)(Marvin Isgur)

            Facts:  Chapter 7 trustee brought suit against officers and directors asserting that they had breached their fiduciary duties under Canadian law.    Directors moved to dismiss.

      Holding:         

“After Stern, the Court's authority over state-law matters (or, in this case, foreign-law matters) is particularly questionable.”   However, Court still had authority to enter interlocutory orders, such as ruling on a motion to dismiss.

#In re Yazoo Pipeline Co., LP, 459 B.R. 636 (Bankr. S.D. Tex. 10/14/11)(Marvin Isgur)

            Facts:  Trustee filed suit to recover damages for misconduct occurring while debtor was in chapter 11.   Trustee filed motion for leave to file second amended complaint.

            Holding:         

Although the claims in this proceeding involve  conduct that took place within the context of a bankruptcy case, bankruptcy law does not alter the state-law character of the claims. The claims would not necessarily be resolved through the claims adjudication process or through the resolution of any other essential bankruptcy matter. This Court does not have authority to enter a final judgment in this matter. On this Court's Recommendation, the District Court has ordered that the reference will be withdrawn after all pretrial matters are concluded.

In re The Heritage Organization, LLC, 459 B.R. 911 (Bankr. N.D. Tex. 10/3/11)(Barbara J. Houser)

            Facts:  Several years after an adverse judgment, defendants moved to vacate the judgment under Rule 60(b)(4) based on the Stern decision.

            Holding:          Judgment is not void for want of jurisdiction unless nor arguable basis for jurisdiction existed in the first place.   Court had statutory jurisdiction.   Because Stern case was not decided for two years after judgment, court “declines to conclude that it lacked any arguable basis for jurisdiction.”

#In re Heights Melrose Group, LLC, 2011 Bankr. LEXIS 153073 (Bankr. S.D. Tex. 9/29/11)(Marvin Isgur)

            Facts:  Debtor filed suit to determine that defendants did not have a claim to certain condominiums.    Defendants claimed that foreclosure sale at which debtor purchased properties was invalid.   Both parties moved for summary judgment.

            Holding:          Court could not enter final orders on parties’ state law claims.   As a result, Court submitted proposed findings and conclusions to the District Court.

*In re Bigler, LP, 458 B.R. 345 (Bankr. S.D. Tex. 8/19/11)(Jeff Bohm)

            Facts:  Bank brought declaratory judgment complaint against other creditors to determine extent, priority and validity of liens.

            Holding:

The broader applicability of the Supreme Court's decision  remains unclear. Other types of disputes frequently decided by bankruptcy courts may now also require final adjudication by Article III courts. A bankruptcy court's authority over matters involving state law causes of action is particularly questionable. Indeed, just as the debtor's counterclaim in Stern was based entirely upon state law, the law governing the dispute in this adversary proceeding is based entirely upon state law. Accordingly, at first blush, it would appear that the undersigned Article I judge does not have the constitutional authority to enter a final judgment in this adversary proceeding. However, for the reasons set forth below, this Court concludes that it does have such authority.

This Court may exercise authority over matters integral to the bankruptcy scheme under the "public rights" exception articulated in Stern. Under Thomas v. Union Carbide Agric. Prods. Co., a right closely integrated into a public regulatory scheme may be resolved by a non-Article III judge.  (citation omitted). The Bankruptcy Code is a public scheme for restructuring debtor-creditor relations, necessarily including "the exercise of exclusive jurisdiction over all of the debtor's property, the equitable distribution of that property among the debtor's creditors, and the ultimate discharge that gives the debtor a 'fresh start' by releasing him, her, or it from further liability for old debts." (citation omitted).

Here, this suit concerns a dispute that must be resolved in order to determine the appropriate distribution among the Debtors' creditors. The determination of lien priority on assets that were once property of the bankruptcy estate are part of the "public rights" exception, as it involves the exercise of the Bankruptcy Court's in rem jurisdiction over the estate. (citation omitted).

Hence, resolution of the lawsuit pending in this Court arises from an express provision of the Plan, the very purpose of which is to distribute cash to the prevailing party or parties--thereby accomplishing the very objective of the public right known as the bankruptcy process  (i.e. paying claims of creditors). (citation omitted). Therefore, not only does this lawsuit involve a right integral to the bankruptcy scheme--the determination of lien priority--but it also involves a right created by the Bankruptcy Code--distribution of property of the estate to creditors pursuant to the Plan. Accordingly, this dispute falls within the undersigned judge's constitutional authority to enter a final judgment.

In re Ritz, 459 B.R. 623 (Bankr. S.D. Tex. 8/4/11)(Jeff Bohm)

            Facts:  Creditor of a corporation asserted that debtor drained corporation of funds.   Creditor asserted claim against the debtor and sought determination of nondischargeability.

            Holding:          Court could enter a final order under the public rights doctrine.

In re Okwonna-Felix, 2011 Bankr. LEXIS 3028 (Bankr. S.D. Tex. 8/3/11)(Jeff Bohm)

            Facts:  Debtor sought approval of compromise of claims against insurance companies.

            Holding:         

Accordingly, because the resolution of the Motion is not based on state common law, but entirely on federal bankruptcy law (both the Rule and the case law instructing how to apply the Rule), the holding in Stern is inapplicable, and this Court has the constitutional authority to enter a final order in this contested matter pursuant to 28 U.S.C. §§ 157(a) and (b)(1).

In re Muhs, 2011 Bankr. LEXIS 3032 (Bankr. S.D. Tex. 8/2/11)(Marvin Isgur)

              Facts:  Creditor filed complaint to determine dischargeability.

            Holding:         

When a bankruptcy court determines the extent of a creditor's nondischargeable claim, the court simply decides that a particular creditor is entitled to something more than the creditor would otherwise get out of the bankruptcy bargain.  Such determinations are inextricably tied to the bankruptcy scheme and involve the adjudication of rights created by the Bankruptcy Code. This case therefore falls within the Bankruptcy Court's authority, and the Bankruptcy Court's judgment is final.

*In re Turner, 462 B.R. 214 (Bankr. S.D. Tex. 7/11/11)(Jeff Bohm)

            Facts:  Chapter 13 debtors filed Complaint for Turnover and Damages against Bank that froze account.

            Holding:          Complaint for turnover was based on automatic stay and not upon state law.

  

The automatic stay is one of the most important--if not the most important--features of the Bankruptcy Code, and it is integral to the public bankruptcy scheme. Its purpose is to enjoin all creditors from taking action against the debtor and the estate so that the debtor may have some breathing room to propose and obtain confirmation of a plan of reorganization which will pay creditors.  (citation omitted). A debtor has a fiduciary duty to his creditors to take the action necessary to pay their claims. (citation omitted). Given the central role of the automatic stay in the bankruptcy scheme, the broad effect of the automatic stay, and the fiduciary duty imposed upon debtors, this Court concludes that enforcement of the automatic stay fits within the "public rights" exception. The automatic stay protects not just one person or entity, but rather protects all of those persons and entities affected by the filing of a bankruptcy petition. (citation omitted). The debtor and the estate benefit because the stay is an injunction that enjoins creditors from unilaterally attempting to collect their respective claims against the estate. (citation omitted). Each of the creditors benefits because no other creditor may unilaterally take action against the estate--which means that the debtor has time to deliberately and carefully file a plan and then obtain confirmation so that all claims can be paid. (citation omitted). Stated differently, the existence of, and the benefits provided by, the automatic stay do not constitute a private right  of any one specific person or entity, but rather comprise a public right that inures to the benefit of all those persons involved in a bankruptcy. Without the enforcement of the automatic stay, reorganization of consumer debtors and business debtors throughout the country would be impossible and would undermine the public policy of allowing honest debtors to obtain a fresh start. Accordingly, because the undersigned judge concludes that the dispute at bar involves a "public right," the undersigned judge concludes that he has the constitutional authority to sign a final judgment in this adversary proceeding.

This is the first Texas opinion that I could find applying Stern v. Marshall.   Since this opinion, Judge Bohm has included a discussion of Stern v. Marshall in virtually every opinion he has written.

New Opinion Makes Sense of "Identifiable, Tangible and Material Benefit" Language From Pro-Snax

In Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5^th Cir. 1998), a panel of the Fifth Circuit made the uncontroversial ruling that a chapter 11 debtor’s attorney could not recover attorney’s fees from the bankruptcy estate after appointment of a trustee.   However, the court went one step further and stated that in order to recover fees for the period prior to appointment of the trustee, the applicant must demonstrate an “identifiable, tangible and material benefit to the estate” in order to be compensated.   Most courts to consider this standard have concluded that when a case does not generate results notwithstanding the best professional efforts of the attorney that compensation may not be allowed except for certain mandatory services.   That consensus was broken when Judge Michael Lynn ruled that an “identifiable, tangible and material result to the estate” means that an attorney acted at the behest of his client acting in the exercise of its business judgment.   In re Broughton Ltd. Partnership, No. 10-42327 (Bankr. N.D. Tex. 4/25/12), a copy of which can be found here.   Judge Lynn’s ruling transforms the standard for compensation from a one-sided contingency fee to a professional judgment standard and is consistent with the text of 11 U.S.C. §330.    (Disclosure:  I am currently appealing a Pro-Snax ruling and will be relying upon the Broughton Ltd. Partnership case.).

What Happened

The facts are straightforward.  The debtors’ business was “the development of high-end residential subdivisions and sales of the developed lots.”  Special counsel was retained to negotiate the sale of 22 lots to a specific purchaser.     The purchaser required that a homeowners association waive certain rights.   When the homeowners association refused, the contract fell through notwithstanding counsel's efforts.  When     the sale fell through, the case ultimately converted.    When special counsel applied for its fees, the U.S. Trustee objected based upon Pro-Snax.  

The Ruling

 The Court noted that bankruptcy courts within the Fifth Circuit following Pro-Snax had required that fees be reasonable on both a prospective basis and based on a retrospective review.    The prospective test is based on section 330(a)(3)(C)  which provides that “the services (be) necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, [the bankruptcy case].”   The retrospective or hindsight test incorporates the Pro-Snax requirement that the services actually result in an “identifiable, tangible and material benefit to the estate.”

Prospective Test

The U.S. Trustee argued that it was not even necessary to apply the retrospective test since the attorney should have realized early on that the proposed transaction would not result in a benefit to the estate.   The Court disagreed, noting that “(t)he proposed sale to SPOT was viewed in late 2010, not only by the court, but by the various parties, as the keystone of Debtors’ potential reorganization.”   Opinion, p. 5.   The Court went on to state that: 

That the transaction was a difficult one to put together and that the idiosyncrasies of the parties might frustrate the efforts of counsel does not mean that counsel was required to cease work and give up. Rather, so long as a professional is doing its principal’s bidding and there is a reasonable prospect of success, the professional is entitled to work in the expectation of being paid.

 Opinion, p. 6.   It is nice to see that the Court did not adopt the position that when the going gets tough, those who want to get paid give up.   

Retrospective Test

The Court approached the question of what constituted an “identifiable, tangible and material benefit to the estate” from several angles.  First, the Court noted that a literal application of the phrase could result in absurd results. 

The problem posed by Pro-Snax is that use of the word “benefit” suggests a positive contribution is required. An “identifiable, tangible, and material” benefit to the estate at first blush would appear to be something that augments the estate. Yet it seems clear that professionals serving a debtor or other fiduciary in a chapter 11 case cannot be limited in their compensation to those activities that actually add to the estate. First, such a determination would exclude from compensation many critical functions performed by professionals in the course of a chapter 11 case. Administrative matters, operational oversight, disputes respecting control, steps in the plan process such as extensions of exclusivity and many other matters dealt with by professionals covered by Pro-Snax do not increase the debtor’s estate or reduce the claims against it – yet the chapter 11 case could not work if professionals did not perform services in connection with these functions.

 

Second, as with the Firm’s work, that work which a professional undertakes doesn’t always lead to success.16 Deals – as with SPOT – fall through. Litigation on behalf of the estate may offer the prospect of substantial recoveries, but will not necessarily be won. It may be that counsel representing Stern, the estate representative in Stern v. Marshall, --- U.S. ----, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011), was unsuccessful, ultimately losing the estate’s case in the United States Supreme Court in a 5-4 decision. It is unthinkable that that counsel’s work leading to that result should be uncompensated.   The very fact that section 328(b) permits (but does not require) retention of professionals on, inter alia, a contingency basis demonstrates that Congress did not intend all professional services to be compensable only on that basis. Yet, as some courts have noted, to apply Pro-Snax as requiring estate augmentation would be tantamount to doing so. 

Opinion, pp. 10-11.

 Digging deeper, the Court looked at the Pro-Snax case itself.   The only clue that the Fifth Circuit gave as to the meaning of “identifiable, tangible and material” was a citation to In re Melp, Ltd., 179 B.R. 636 (E.D. Mo. 1995).   That case in turn referred to: 

In undertaking a “benefit analysis,” a court should consider: (1) whether the debtor’s attorney’s actions duplicated the duties of the trustee or the trustee’s counsel under 11 U.S.C. § 1106; (2) whether the services have in fact, obstructed or impeded the administration of the estate; and (3) whether the debtor’s attorney’s actions are consistent with the debtor’s duties under 11 U.S.C. § 521.

 In re Melp, 179 B.R. at 640.    Since the Fifth Circuit relied on Melp in formulating its test, it is only reasonable to see what the Melp Court meant.

Judge Lynn also examined the construction given to “identifiable, tangle and material benefit” by District Judge Jane Boyle in Kaye v. Hughes & Luce, LLP, (In re Gadzooks, Inc.), 2007 WL 2059724, at *9 (N.D. Tex. Jul.13, 2007).   I have previously written about the Gadzooks case here, here and here. 

The Gadzooks court, which applied the benefit test to counsel representing an equity committee, struggled with how to reconcile the Pro-Snax requirement of an “identifiable, tangible, and material benefit” to the estate, including its suggestion of a retrospective review of counsel’s work, with section 330(a)(3)(C) which indicate a professional’s efforts should be assessed prospectively, as of the time they were to be performed. Judge Boyle, in Gadzooks, concluded that the requirement set by the Court of Appeals of a benefit to the estate constituted a gloss on the provision in section 330(a)(1)(A) that counsel be awarded “reasonable compensation for actual, necessary services rendered by the…professional person.” See In re Gadzooks¸ 2007 WL 2059724, at *9. That is, services will benefit the estate if they are actual and necessary. 

Opinion, pp. 14-15.    

The Court also looked to how similar language in section 503(b)(1) has been interpreted. 

As it happens, the term “actual, necessary” is found not only in section 330(a)(1)(A) but as well in section 503(b)(1)(A), where it modifies the words “costs and expenses of preserving the estate” and limits what costs and expenses are entitled to priority payment as administrative claims. As used in section 503(b)(1)(A), “actual, necessary” clearly does not mean administrative expenses are limited to only those that enhance or at least preserve a debtor’s estate. It has been black letter law since the Supreme Court rendered its decision in Reading Co. v. Brown, 391 U.S. 471, 478, 88 S.Ct. 1759, 20 L.Ed.2d 751 (1968), that torts committed by an estate representative in the course of performing his, her or its duties give rise to claims entitled to administrative priority. This is because, as the Court reasoned in Reading, a bankruptcy estate, just like any other participant in the business world, must pay those costs necessarily incident to its operations, including satisfying claims arising from torts attributable to the estate.

 

Similar reasoning can be applied to the efforts of the professionals of a debtor in possession (or other statutory bankruptcy fiduciary). It is the duty of a debtor in possession –like any estate representative – to realize any possible value from assets of the estate. If it eventually proves true that an asset cannot be realized upon, that does not mean it should not be investigated and its liquidation (or other means of realization) pursued, so long as, as the Pro-Snax court observed, “the chances of success…outweigh the costs of pursuing the action.” 157 F.3d at 426. Thus, for example, in Stern v. Marshall, pursuit of Stern’s counterclaim was appropriate and compensable, since the chances of success were good. That the case ultimately was lost 5-4 in the Supreme Court (on the basis of the bankruptcy court’s constitutional inability to enter a final judgment on Stern’s counterclaim) does not change the fact that the estate representative and estate professionals were doing their duty in pursuing it. 

Opinion, pp. 15-16.

The Conclusion

Having considered all of these factors, the Court reached its ultimate conclusion that a professional confers an identifiable, tangible and material benefit to the estate when it performs services at the direction of the representative of the estate which is acting within its business judgment. 

The court today holds that a professional provides an “identifiable, tangible and material benefit” to a bankruptcy estate within the meaning of Pro-Snax through assisting the estate representative in administering an asset of the estate, whether or not the effect of administration of the asset is enhancement of the estate, so long as the professional’s services are performed at the direction of the estate representative and the estate representative is acting in accordance with the Code and its sound business judgment.  In doing so, the court focuses on the nature of the benefit provided but also takes account of public policy and an estate representative’s decision making authority in bankruptcy.

 

With regard to the latter, the court relies on an estate representative’s sound business judgment in approving acts outside the ordinary course of business.  (citation omtted).Unless the manner in which an estate representative arrives at a decision is seriously flawed, the court will defer to the estate representative.  (citation omitted). A professional should similarly be able to rely on its client’s business judgment in acting in accordance with the client’s instructions.

 

As to public policy, professionals are retained by an estate representative to advise and assist the representative in carrying out his, her or its duties under the Code. To burden professionals by making their compensation contingent upon the result of the estate representative’s decisions must necessarily skew the regime intended in the Code and will surely create conflicts where a professional believes its client’s decision, though arrived at through due diligence, is not the right one. Had Congress wished professionals retained under section 327 of the Code to second-guess and perhaps veto decisions of a trustee or debtor in possession, it surely would have said so. 

Opinion, pp. 17-18.

What It Means

While I acknowledge my own bias, I think that Broughton Ltd. Partnership should change the way that Courts in the Fifth Circuit interpret Pro-Snax.     Judge Lynn’s interpretation allows courts to follow the language used in Pro-Snax without doing violence to the language or the logic of the Code.

Unlocking the Code    

Section 330(a) contains several criteria for allowing compensation in bankruptcy, but does not use the words identifiable, tangible and material benefit.   In fact, it expressly adopts a prospective analysis.

The statute reads:

§ 330.  Compensation of officers

(a) (1) After notice to the parties in interest and the United States Trustee and a hearing, and subject to sections 326, 328, and 329, the court may award to a trustee, a consumer privacy ombudsman appointed under section 332, an examiner, an ombudsman appointed under section 333, or a professional person employed under section 327 or 1103--       (A) reasonable compensation for actual, necessary services rendered by the trustee, examiner, ombudsman, professional person, or attorney and by any paraprofessional person employed by any such person; and      (B) reimbursement for actual, necessary expenses.

***

      (3) In determining the amount of reasonable compensation to be awarded to an examiner, trustee under chapter 11, or professional person, the court shall consider the nature, the extent, and the value of such services, taking into account all relevant factors, including--       (A) the time spent on such services;      (B) the rates charged for such services;      (C) whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title;       (D) whether the services were performed within a reasonable amount of time commensurate with the complexity, importance, and nature of the problem, issue, or task addressed;       (E) with respect to a professional person, whether the person is board certified or otherwise has demonstrated skill and experience in the bankruptcy field; and       (F) whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title.    (4) (A) Except as provided in subparagraph (B), the court shall not allow compensation for--          (i) unnecessary duplication of services; or          (ii) services that were not--             (I) reasonably likely to benefit the debtor's estate; or             (II) necessary to the administration of the case.

***

     (6) Any compensation awarded for the preparation of a fee application shall be based on the level and skill reasonably required to prepare the application.   

***

 (emphasis added).

Interpreting Pro-Snax to require a positive result in order to get paid would be to eliminate the words “at the time at which the services were rendered” and “reasonably likely to benefit the debtor’s estate” from section 330(a).  Such a view (even though it has been the prevailing one) effectively accuses the panel of negligence at best or judicial activism at worst.   

This tension was acknowledged by Judge Frank Monroe in In re Weaver, 336 B.R. 115 (Bankr. W.D. Tex. 2005), when he stated: 

Applicant Borsheim argues that Pro-Snax is at odds with the statute and misinterprets it since the statute plainly authorizes fees "for actual, necessary services"-as well as services that are "reasonably likely to benefit the debtor's estate".    Even if such be true, this Court is constrained to follow the 5th Circuit's interpretation. 

Weaver, at 119. 

Judge Lynn, by following Judge Boyle’s conclusion that “identifiable, tangible and material benefit” was merely a gloss upon “actual, necessary services,” has tethered Pro-Snax to the language of the Code and has consistently followed the underlying authority relied upon by the Pro-Snax panel.

 

With all respect to Judge Monroe (who was a venerable and well-respected judge), it is far better to follow the Fifth Circuit and follow the language of the Code at the same time.   Judge Lynn has succeeded in doing both.

(In fairness to Judge Monroe, he had a subsequent opinion in In re Spillman Development Group, Ltd., 376 B.R. 543 (Bankr. W.D. Tex. 2007),  in which he which took a more nuanced approach to Pro-Snax.) 

When the Going Gets Tough

The Broughton Ltd. Partnership opinion is also good for the system.    The English common law system adopted in the United States relies upon an adversarial system in which opposing parties are represented by zealous advocates.    Bankruptcy is a multi-party process.   If the most aggressive creditor can threaten debtor's counsel with not getting paid, debtor's counsel will have an incentive to placate that party at the expense of everyone else.   Moreover, if the court increases the risk of not getting paid, then either lawyers will demand higher fees to compensate for that risk or will forego those representations altogether, leaving them to less qualified lawyers.    In order for the system to work, good lawyers need to have a reasonable opportunity to be compensated without being a guarantor of the success of their client's case.  While some debtors may be less than deserving scoundrels who use bankruptcy to escape payment of their just debts, the opposite is also true.   Some creditors are more interested in using their position to prevent debtors from paying their debts, either so that they can foreclose and reap a windfall or simply to crush another party out of malice and spite.    While the bankruptcy court cannot grant equal resources to all parties, it can at least avoid penalizing one side.