STERN V. MARSHALL SEMINAR MATERIALS PRESENTED 12/6/12 TO WORCESTER COUNTY BAR ASS'N BANKRUPTCY SECTION

STERN v. MARSHALL, 131 S.Ct. 2594 (2011):

WHY SHOULD YOU CARE?

Kevin C. McGee, Partner

Seder & Chandler, LLP

339 Main Street, 3^rd Floor

Worcester, MA 01608
©Kevin C. McGee

• The Stern v. Marshall Facts:

• Former Playmate of the Year Anna Nicole Smith (real name: Vickie Lynn Marshall) (“Smith”) marries J. Howard Marshall II (“Howard”), who is very old and very rich.

• One year later – Howard dies & leaves Smith out of his will. Before his death, Smith files suit in Texas and accuses Howard’s son – E. Pierce Marshall (“Pierce”) – of shenanigans to keep her out of the will.

• Smith files bankruptcy after Howard’s death, with her claims against Howard’s estate –separate litigation (up and down the federal court system and the Texas court system) ensues.

• In the Smith bankruptcy, Pierce files a non-dischargeability complaint and a proof of claim based upon his allegations that Smith defamed him through having her lawyers publicize (through the press) that Pierce defrauded Smith to gain control of Howard’s assets and estate (the “Pierce Proof of Claim”).

• Smith objects to the Pierce Proof of Claim and asserts a counterclaim against Pierce on the theory of his tortious interference with the gift she expected to get from Howard.

• Determinations in the California bankruptcy court on both claims – Pierce expresses no issue or problem with the bankruptcy court hearing issues on the Pierce Proof of Claim, but objects to the hearing on the Smith counterclaim. Smith gets summary judgment (in 1999)  on the Smith Proof of Claim, and judgment (after a 2000 bench trial) in her favor on her counterclaim -- $400 million in compensatory damages & $25 million in punitive damages.

• Post-trial – Pierce argues that Smith’s counterclaim was not a “core proceeding” & that the bankruptcy court had no authority to issue final findings of fact and rulings of law (“Final Rulings”) on the counterclaim. Smith argues that the counterclaim was “core” under 28 U.S.C. §157(b)(2)(C)[1] (as the bankruptcy court had determined in issuing its final judgment).

• The California US District Court agreed with Pierce that the counterclaim was not “core”, notwithstanding §157(b)(2)(C), because (in essence) it was not a “mandatory” counterclaim to the Pierce Proof of Claim (i.e., arose from different facts and occurrences), & treated the bankruptcy court findings and judgment as “proposed”[2]. The District Court then confirmed the bankruptcy court rulings and issued its own judgment in favor of Smith, in the amount of $44,292,767.33 (combining compensatory & punitive damages).  

• A procedural mess followed, with the case going up to the 9^th Circuit, then up to the SCOTUS (on the issue of a bankruptcy court’s power to decide probate matters), then back to the 9^th Circuit. In the end, the 9^th Circuit concluded that the District Court should have given the Texas jury verdict preclusive effect, and ruled in favor of Pierce. Another writ of certiorari followed and the SCOTUS granted it.

• By the time the SCOTUS decided the case in 2011, both Smith and Pierce were dead, and their respective estates were carrying on the fight.

• The Stern v. Marshall Majority Rulings (Roberts, CJ, with Scalia, Kennedy, Thomas & Alioto, JJ joining):

• “Core” or “Noncore” under 28 U.S.C. §157(b)?

• Under the terms of §157(b)(2)(C), the bankruptcy court had statutory authority to enter Final Rulings on the Smith counterclaim to the Pierce Proof of Claim.

• The bankruptcy court could also enter Final Rulings on the Pierce Proof of Claim because: (i) although Pierce claimed that the Pierce Proof of Claim involved a “personal injury tort” which the bankruptcy court lacked jurisdiction to hear under 28 U.S.C. §157(b)(5), that statute is not jurisdictional; and (ii) Pierce’s expressions of consent to the bankruptcy court determination of the Pierce Proof of Claim waived his objection to such determination based on §157(b)(5). Justice Roberts noted that Pierce did consent to the determination of the Pierce Proof of Claim by filing the proof of claim and then affirmatively stating on other occasions that he had no problem with the bankruptcy court's determination of the Pierce Proof of Claim. 131 S.Ct. at 2607-08.

• On the latter point, Justice Roberts wrote: “If Pierce believed that the Bankruptcy Court lacked the authority to decide his claim for defamation, then he should have said so -- and said so promptly. See United States v. Olano, 507 U.S. 725, 731 (1993)(‘”no procedural principle is more familiar to this Court than that a constitutional right,” or a right of any other sort, “may be forfeited ... by the failure to make timely assertion of the right before a tribunal having jurisdiction to determine it.”’)[.]” 131 S.Ct. at 2608.

• Does the Bankruptcy Court have Authority to Determine Smith’s State Law Counterclaim?

• Despite its conclusion that the Smith counterclaim was a “core” proceeding as defined by the statute, the majority opinion went on to examine the bankruptcy court’s authority to issue Final Rulings under Article III of the U.S. Constitution.

• Justice Roberts first trots out the plurality opinion in Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 102 S.Ct. 2858 (1982) and the idea that Congress cannot delegate, through legislation, either the Article III judicial power or the right of litigants to have state law claims heard by an Article III court. 131 S.Ct. at 2608-10.

• The majority then goes on to examine whether the core/non-core distinction in 28 U.S.C. §157, with the bankruptcy courts operating as “adjuncts” of the district courts, fits within the “public rights” exception to Article III jurisdiction permitting legislatively-created adjudicators to necessarily determine state law claims.

• In teasing out the “public rights” exception, Justice Roberts notes that the following situations qualify for the exception: (1) actions in which the U.S. Government is a party to the litigation; and (2) actions in which the rights involved are “integrally related to particular federal government action” or a federal regulatory scheme. 131 S.Ct. at 2611-13.

• Justice Roberts and the majority cite the circumstances in Commodity Futures Trading Commission v. Schor, 478 U.S. 833, 106 S.Ct. 3245 (1986) as a situation in which a state law claim could be determined under the “public rights” exception to Article III jurisdiction: specifically, when a mandatory state law counterclaim, arising from the same facts and occurrences, is asserted in response to a claim that falls within the determination authority of an agency acting within a “specific and limited regulatory scheme.” 131 S.Ct. at 2613-14.

• The majority contrasts the Schor circumstances with a trustee’s pursuit of fraudulent transfer claims in Granfinanceria S.A. v. Nordberg, 492 U.S. 33, 109 S.Ct. 2782 (1989), in which the SCOTUS held such claims, asserted against a noncreditor, were “private rights” as opposed to “public rights,” even if a statute granted the right to pursue the fraudulent transfer action. 131 S.Ct. at 2614.

• After this review, Justice Roberts concludes that the Smith counterclaim is more like the fraudulent transfer claim than it is the counterclaim in Schor, and concludes that the Smith counterclaim neither falls within the public rights exception nor “flows from a federal statutory scheme …[in which the counterclaim’s adjudication] is completely dependent upon ‘adjudication of a claim created by federal law’”.Id.

• Accordingly, the majority concludes that the California bankruptcy court lacked constitutional authority, under Article III, to make Final Rulings on Smith’s counterclaim to the Pierce Proof of Claim, notwithstanding its “core” nature under 28 U.S.C. §157. In making this conclusion, the majority dismisses: (1) any “implied” consent to the determination of the Smith Counterclaim through the filing of the Pierce Proof of Claim – because of the lack of factual connection between the Pierce Proof of Claim and the Smith Counterclaim, and the need for separate findings for each claim, 131 S.Ct. at 2615-18; (2) the bankruptcy court’s “adjunct” status to the district court, since such status is not accompanied by an appropriate limitation as to the areas that a bankruptcy court can decide, 131 S.Ct. at 2618-19; and (3) the concern that a two-tier adjudication of state law claims, with  the need to confirm and approve proposed findings and rulings through de novo review, does not justify overriding Article III constitutional concerns even if the process is inefficient, expensive or impractical, 131 S.Ct. at 2620.

• On the latter point, the majority does appear to backtrack a little on the scope of its decision: “[W]e are not convinced that the practical consequences of such limitations on the authority of bankruptcy courts to enter final judgments are as significant as [Smith] and the dissent suggest…As described above, the current bankruptcy system also requires the district court to review de novo and enter final judgment on any matters that are "related to" the bankruptcy proceedings, § 157(c)(1), and permits the district court to withdraw from the bankruptcy court any referred case, proceeding, or part thereof, § 157(d). Pierce has not argued that the bankruptcy courts ‘are barred from `hearing' all counterclaims’ or proposing findings of fact and conclusions of law on those matters, but rather that it must be the district court that ‘finally decide[s]’ them.... We do not think the removal of counterclaims such as Vickie's from core bankruptcy jurisdiction meaningfully changes the division of labor in the current statute; we agree with the United States that the question presented here is a "narrow" one.” 131 S.Ct. at 2620.

• Is the Stern v. Marshall Effect on Bankruptcy Litigation Broad or Narrow?

• Answers from Circuit Courts:

•  Yes, It is Narrow:

• 11^th Circuit:  Stern v. Marshall involved a “permissive” state law counterclaim to a proof of claim, and has no application when the counterclaim is “mandatory”, i.e. arising from the same facts and occurrences, as in loan payment recoupment claims asserted in response to a secured creditor’s action to determine the validity, extent and priority of its lien. Sundale, Ltd. v. Florida Associates Capital Enterprises, LLC (In re Sundale, Ltd), __ F 3d __ (Case No. 12-11450 11^th Cir. 11/29/12).

• 2^nd Circuit: Stern v. Marshall holding is narrow and has no application to a bankruptcy court injunction issued to stay asbestos litigation against the debtor’s parent company,  in aid of the automatic stay. Pfizer, Inc. v. Law Offices of Peter G. Angelos (In re Quigley Co., Inc.), 676 F.3d 45 (2^nd Cir. 2012).

• 1^st Circuit: Stern v. Marshall is limited in scope and inapplicable to a Truth in Lending rescission action, when the bankruptcy court’s resolution of that action was necessary to its determination of the secured creditor’s motion for relief from stay. DiVittorio v. HSBC Bank USA (In re DiVittorio), 670 F.3d 273, 282 n.4 (1st Cir. 2012)

• “It Depends”:

• 9^th Circuit: Although Stern v. Marshall certainly applied to a bankruptcy court’s determination of a fraudulent transfer case under 11 U.S.C. §548 against a noncreditor, the right to a hearing in an Article III court can be waived by a party, and the bankruptcy court could still issue final findings of fact and rulings of law on the claim when the defendant had failed to object or indicate a lack of consent to such hearing, until the final judgment was challenged on appeal. Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency, Inc.), ___ F.3d ___ (Case No. 11-35162 9^th Cir. 12/4/12).

• No, It is Broad and Far-Reaching:

• 6^th Circuit: In determining a debtor’s state law fraud counterclaim against a secured creditor in the context of the debtor’s declaratory judgment action to disallow and discharge the creditor’s secured and unsecured claims, the Sixth Circuit stated: “ Stern thus provides a summary of the law in this area: When a debtor pleads an action under federal bankruptcy law and seeks disallowance of a creditor's proof of claim against the estate—as in Katchen—the bankruptcy court's authority is at its constitutional maximum.(my emphasis – KCM) 131 S. Ct. at 2617-18. But when a debtor pleads an action arising only under state-law, as in Northern Pipeline; or when the debtor pleads an action that would augment the bankrupt estate, but not ‘necessarily be resolved in the claims allowance process[,]’ 131 S. Ct. at 2618; then the bankruptcy court is constitutionally prohibited from entering final judgment. Id. at 2614.” Waldman v. Stone,  ___ F.3d ___, ___ , 2012 WL 5275241 (6th Cir. Oct. 26, 2012).

• What Are the Courts Doing to Accommodate Stern v. Marshall in Practice?

• National Rulemaking: In September 2012, the Advisory Committee on Bankruptcy Rules for the Judicial Conference of the United States  proposed amendments to Bankruptcy Rules 7008, 7012, 7016, 9027, and 9033 to address the “inefficiencies” of Stern v. Marshall. The common theme in each rule is to require each party to state whether or not the party consents to the bankruptcy court’s final determination of facts and final rulings, with opportunities at the pleading stage (proposed Fed. R. Bankr. P. 7008 & 7012), if the case is removed from another court (proposed Fed. R. Bankr. P. 9027), and at pre-trial conferences (proposed Fed. R. Bankr. P. 7016). The proposed rules also eliminate any requirement that the parties state whether each count is “core” or “non-core”[3]. Proposed Fed. R. Bankr. P. 9033 follows this trend in eliminating any reference to 28 U.S.C. §157(c)(1) with respect to proposed findings and rulings issued by a bankruptcy court, thus acknowledging that proposed findings and rulings may be required in “core” matters as well as “non-core” matters.

• Local Rulemaking: At least one bankruptcy court, has adopted the “get consent to everything first” approach taken up by the Advisory Committee to the Judicial Conference. Bankr. SDNY Local Bankruptcy Rule 7008.1 (adopted 4/16/12); see also Local Rule 7012-1 (Bankr. D. Md.) (requiring statement of consent in pleadings); Local Rule 7008 (Bankr. W.D. Mich.)(same). U.S. District Courts have mostly reacted by reaffirming the referral of bankruptcy matters to bankruptcy courts, and requiring that all determinations under Stern v. Marshall be made, in the first instance, by the bankruptcy court (as opposed to through a motion to withdraw reference addressed to the district court). Amended Standing Order or Reference (D. Del. 2/29/12); Standing Order of Ref. 6:12-MC-26-ORL-22 (M.D. Fla. 2/22/12); L.R. 206 (D. Mass. effective 6/5/12); Amended Standing Order of Reference (S.D.N.Y. 1/31/12); General Order No. 2011-12 (S.D. Tex. 11/29/11)[4].

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[1]  §157(b)(2)(C) provides that “Core proceedings include, but are not limited to, …counterclaims by the estate against persons filing claims against the estate[.]” Pursuant to §157(b)(1), bankruptcy courts “may hear and [finally] determine” all core proceedings arising under title 11, and enter orders and judgments subject to appellate review as a final order, judgment or decree under 28 U.S.C. §158. Cf. 28 U.S.C. §157(c)(1) “A bankruptcy court may hear a proceeding that is not a core proceeding but that is otherwise related to a case under title 11. In such proceeding, the bankruptcy court shall submit proposed findings of fact and conclusions of law to the district court, and any final order or judgment shall be entered by the district court after considering the bankruptcy judge’s proposed findings and conclusions and after reviewing de novo those matters to which any party has timely and specifically objected.”

[2] Interestingly, the Texas state court had conducted a separate jury trial on the parties’ dispute and rendered a verdict in Pierce’s favor; however, the District Court declined to give that verdict preclusive effect.

[3] But see 28 U.S.C. §157(b)(3) – “The bankruptcy judge shall determine, on the judge’s own motion or on timely motion of a party, whether a proceeding is a core proceeding … or is a proceeding that is otherwise related to a case under Title 11. A determination that a proceeding is not a core proceeding shall not be made solely on the basis that its resolution may be affected by State law.” One can assume that the Advisory Committee wants to avoid messy pleadings that state that a matter is “core” under §157, but is otherwise “non-core” for the purposes of the bankruptcy judge’s authority to enter final findings and rulings.

[4] In citing all these rules, I acknowledge the work done by David Mawhinney, law clerk to Judge Frank Bailey of the Massachusetts Bankruptcy Court; he collected these rules in materials presented to the district court judges for Massachusetts and was a driving force in proposing Local Rule 206 to them. 

FIRST LESSON: “A” is for “Avoidance” and “Abandonment”

DISCLAIMER:  Nothing on this blog is intended to be specific or complete legal advice and is for general informational purposes only. In other words, you are only getting the tip of the iceberg in this blog – call and schedule a consultation with me at (508) 757-7721 ext. 112 if you think what you read here might apply to you and your situation. 

First, know that the bankruptcy law and Webster’s Dictionary have different definitions of “avoidance” and “abandonment”. The two terms also describe very different powers that a trustee in bankruptcy may use in your case.

A trustee’s “avoidance” powers are something that most debtors and creditors want to – well, to be honest, avoid. The Bankruptcy Code gives a trustee the right to bring a lawsuit to:

1.                  Avoid and recover payments a debtor made to any creditor on outstanding debts in the period ninety days prior to the date of the bankruptcy filing. These are called “preferences”, and can be hard for a creditor to fight, although there are some defenses available. A preference in a consumer bankruptcy case must be $600.00 or more (made in a single payment or as a total of multiple payments made during the 90 day period) before a trustee can bring a lawsuit to recover the preference; for businesses, the minimum ante is $5,850.00 or more.. One example for consumers: big paydowns on a credit card debt in the 90 day period, especially if the credit card company has stopped any new charges on the card. Businesses know all too well that money that comes in from a troubled account receivable is money that may just be making a brief visit to their bank accounts. There are defenses a creditor can raise -- but that's a separate post.

2.                  Avoid and recover payments a debtor made to his or her “insiders” on outstanding debt in the period one year prior to the date of the bankruptcy filing. These are called “insider preferences”. Who is an “insider”? The usual suspects are your spouse, your parents, your kids, your brothers or sisters, aunts and uncles, grandparents, your in-laws – pretty much anyone related to you by blood or by marriage. Your good friends and your employer are also possible insiders, depending on the closeness of your relationship with them. If you are in business, insiders include anyone who is your partner or who has a significant investment in your business. If you are a corporation or an LLP, the insider category includes the members, directors, officers, and any person who controls 20% or more of the shares or voting power in the business. 

       One quirk is that, if the payment is made within the year but before the three month period prior to a bankruptcy filing, the trustee has to prove that the debtor was “insolvent” at the time of payment – i.e., that the amount of your debts due and owing exceeded the fair value of your assets. In the ninety day period prior to the bankruptcy filing, you are “presumed” to be insolvent, and the trustee does not have to provide evidence on this issue unless the preference defendant comes up with evidence to the contrary. A typical example of a consumer “insider preference” is repaying Mom and Dad for the loans they gave you to help you get over the hump.

3.                  Avoid and recover transfers of your property made for less than a fair payment for the value of the property, if you were “insolvent” at the time (see definition of “insolvency” above). These are called “fraudulent transfers,” and can be very simple or very complicated to try. Simple cases include transferring your house to your spouse or a relative in a deed that recites “for consideration of less than $100.00” – always a bad idea (even for “estate planning” purposes) and usually can be undone by a trustee, if the trustee proves you were insolvent at the time.  Suppose you weren’t insolvent at the time, but you were expecting a big judgment against you or planned to take on a lot of debt in the near future – this is still a “fraudulent transfer” of the “intentional” variety, because you were deeding over the property with the idea of protecting it from your present and future creditors. And the trustee can still get it back.

4.                  Avoid defective liens on your property. If you have a mortgagee or other lien creditor who failed to cross all the “t”s and dot all the “i”s when that creditor took a lien on your property, the trustee can step into the shoes of an imaginary judgment lien creditor or a bona fide purchaser of your property, avoid the bad lien, and take the place of that creditor in the “priority” of distribution on that property – if the defective mortgage would have been first in line for the proceeds of the property’s sale, the trustee takes the place of that mortgagee. One illustration – your mortgage lender records a mortgage on your property with the wrong description of the property attached – the trustee can pretend that he or she is a judgment lien creditor on your property, get rid of the mortgage, and take the mortgage’s place on the property (leaving your mortgage lender with only a general claim in the case and no lien).

Let’s leave the unpleasant topic of “avoidance” and move on to another subject: “abandonment”. In general, a debtor's bankruptcy estate includes all of his, her or its property of whatever kind, wherever located, in whatever manner the debtor holds it (i.e., in the debtor's own name or through a trust), and whether or not the debtor lists it in the schedule of assets filed with the bankruptcy court. If you are a debtor, listing all of your property in your asset schedules is important for many reasons, not the least of which is that listing the property gives the trustee the opportunity to look over the property and decide whether or not the trustee wants to sell the property. Listing all property owned also allows the debtor to claim “exemptions” in certain property, which will prevent the trustee from selling or taking all of the sale proceeds of that property.

 If the trustee decides that he or she cannot sell certain property, that the property is worthless, or decides that he or she does not want the burden of maintaining and insuring the property, the trustee has two options:

A.                 The trustee can decide to take the property out of the bankruptcy estate immediately, and file a “notice of abandonment” with the bankruptcy court. If enough time passes and there is no objection, the debtor will get back control of the abandoned property; however, the automatic stay also stops protecting the property.

B.                 The trustee can hold onto the property until he or she decides to make a final distribution to your creditors and close the case. The legal effect of closing the case is to abandon all property not otherwise sold or previously abandoned back to the debtor. The closing of the case also ends the automatic stay as to all property abandoned.

Important point to remember: if the debtor doesn’t disclose something he, she or it owns (like a lawsuit for injury) and the trustee closes the case, the property is not really “abandoned” because the trustee never had a chance to decide whether or not to turn that property into cash for creditors. There are many consequences – civil and criminal -- coming to the debtor who hides property from a trustee, but one sure consequence is that a case can be “reopened” to deal with newly discovered property that should have been disclosed when the case was originally open. When in doubt, disclose!

Vocabulary Words and Quick Definitions from an Impudent Lawyer :

“Trustee in Bankruptcy” – All powerful being whose sole purpose is to locate property in your case to turn into cash and pay it out to your creditors.

“Avoidance Power”  --  A trustee’s right to take back what is yours, even though you gave it to someone else. Also, a trustee’s right to jump on any mistake a creditor made in putting a lien on your property, and take advantage of that creditor’s misfortune.

“Preference” – A payment you make with a three month string on it, attached to a trustee’s fishing line.

“Insider” – People you know and love, in whom the trustee takes an unnatural interest.

“Insider Preference” – A payment with a one year string on it, sitting in the pocket of someone you know and love.

“Insolvency” – Owing champagne debt and having only beer money to pay for it.

“Presumption” – A fact known to be absolutely true unless and until it is shown to be completely false.

“Fraudulent Transfer” – Giving someone much, much more than you ever get back from them.

“Intentional Fraudulent Transfer” – Giving someone much, much more than you ever get back from them, and liking it that way.

“Priority” – Your creditors’ grown-up version of “King of the Hill,” using your property as the hill.

“Abandonment” – The trustee’s rejection of unloved property.

“Exemption” – Limited protection for your house, your car, and for any of your property that a trustee probably couldn’t sell anyway.  

©Kevin C. McGee