<iframe src="//www.googletagmanager.com/ns.html?id=GTM-NQZ8BZF&l=dataLayer" height="0" width="0" style="display:none;visibility:hidden"></iframe>

Bellingham, the Bankruptcy Courts, and Core Proceedings: One Question Answered; Many Remain Unanswered

Article

The Business Advisor - Special Alert

June 10, 2014

In its 2011 opinion in Stern v. Marshall, the Supreme Court put at question the authority of bankruptcy courts to fully adjudicate matters Congress had characterized as core proceedings in 28 U.S.C. § 157(b). This past Monday, June 9, 2014, the Court issued its opinion in Executive Benefits Insurance Agency v. Arkison, Chapter 7 of Estate of Bellingham Insurance Agency, Inc. (“Bellingham“). In a break from tradition, Bellingham is a unanimous opinion, with no dissents or concurrences. However, the Bellingham Court framed the issue before it narrowly and declined to answer many of the questions concerning the authority of the bankruptcy courts that have arisen since Stern v. Marshall was decided. Bellingham, therefore, leaves a number of interesting – and important – questions unanswered.

Factual and Procedural History
Nicolas Paleveda and his wife owned, inter alia, Bellingham Insurance Agency, Inc. (“BIA”). BIA became insolvent and ceased operations on January 31, 2006. The next day Paleveda used BIA funds to incorporate Executive Benefits Insurance Agency (“EBIA”). BIA’s assets were transferred to EBIA. BIA filed a voluntary chapter 7 bankruptcy opinion on June 1, 2006. The chapter 7 trustee subsequently commenced a fraudulent transfer action under, inter alia, 11 U.S.C. § 544, asserting claims under the Washington state fraudulent transfer law. The bankruptcy court granted summary judgment in favor of the chapter 7 Trustee on all claims, including the state law fraudulent transfer claims. EBIA appealed the summary judgment to the district court. The district court conducted a de novo review, affirmed and enter judgment for the chapter 7 trustee against EBIA.

EBIA appealed to the United States Court of Appeals for the Ninth Circuit. After EBIA filed its opening brief, the Supreme Court decided Stern v. Marshall. EBIA moved to dismiss the appeal on the grounds that the Constitution did not permit Congress to vest bankruptcy courts with the authority to enter final judgments in fraudulent conveyance actions. The Ninth Circuit denied the motion and affirmed the judgment of the district court. The Ninth Circuit held that bankruptcy courts lack the authority to enter final judgments on fraudulent conveyance claims, absent consent by all parties. The Ninth Circuit found that EBIA had impliedly consented to the bankruptcy court entering final judgment in the chapter 7 trustee’s fraudulent transfer action. Alternatively, the Ninth Circuit found that the bankruptcy court’s summary judgment could be treated as proposed findings of fact and conclusions of law subject to de novo review by the district court, which de novo review EBIA had, in fact, received.

The Supreme Court’s Opinion
The Court began Bellingham by reaffirming its holding in Stern v. Marshall that Article III prohibits Congress from authorizing bankruptcy courts to finally adjudicate certain claims, including certain claims (in Stern v. Marshall, state-law counterclaims) Congress designated as core proceedings in 28 U.S.C. § 157 (such claims, hereafter, “Stern claims”). However, the Bellingham Court acknowledged that, in Stern, it did not address the procedures the bankruptcy courts must follow with respect to Stern claims. It is that fairly narrow issue that the Court addresses in Bellingham.

The focus of the Court’s analysis is a demonstration that the bankruptcy jurisdictional statutes do not create a statutory gap vis-à-vis Stern claims. The Court acknowledged that there is no express statutory provision for dealing with Stern claims. However, the Court also noted the bankruptcy jurisdictional statute contains a severability provision which allows bankruptcy and district courts to treat Stern claims as non-core. See 98 Stat. 344, note following 28 U.S.C. § 151. The Court reiterated its approach to severability, stating that the Court ordinarily gives effect to the valid portion of a partially unconstitutional statute as long as the valid portion remains fully operative as law and it is not evident from the statutory text that Congress would prefer that there be no statute to a judicially modified statute. The Court opined that the application of the core procedures set forth in 28 U.S.C. § 157 to Stern claims is constitutionally invalid. However, the bankruptcy jurisdictional statute also includes 28 U.S.C. § 157(c), which sets forth the procedures for the treatment of non-core claims by bankruptcy courts. According to the Court, because there is no indication that Congress intended that Stern claims to remain suspended in a procedural limbo, the procedures governing non-core claims are applicable to Stern claims.

Turning to the facts of Bellingham, the Court noted that Congress categorized fraudulent transfer actions as core proceedings in which bankruptcy courts are authorized to enter final judgments. The Court also noted that 28 U.S.C. § 157(c)(2) authorizes bankruptcy courts to enter final judgments in non-core proceedings, if all parties consent. However, because none of the parties to Bellingham disputed that “the fraudulent transfer claims in [the Bellingham] case” are not core, the Court merely “assume[d] without deciding” that the fraudulent transfer claims against EBIA were Stern claims. The Court, nevertheless, was constrained to conclude that fraudulent transfer claims were “related to” the bankruptcy case and, therefore, the procedures for non-core proceedings set forth in 28 U.S.C. § 157(c) apply to such actions. The Court found that the bankruptcy and district courts effectively complied with 28 U.S.C. § 157(c). The Court concluded that the bankruptcy court’s summary judgment should be treated as proposed findings of fact and conclusions of law and that EBIA received the de novo review by the district court of the bankruptcy court’s “proposed findings and conclusions” to which it was entitled under 28 U.S.C. § 157(c).

In sum, under Bellingham, when presented with a Stern claim such as a fraudulent transfer claim, the bankruptcy should treat it as a non-core/related to matter. The bankruptcy court will issue proposed findings of fact and conclusions of law. The district court will review the matter de novo and enter a final judgment. The Supreme Court made it clear, however, by characterizing the District Court’s opinion in Bellingham as a “reasoned opinion,” that the district court must, in fact, conduct a de novo review of the bankruptcy court’s proposed findings and conclusions and not rubber-stamp them.

Open Questions
Bellingham is important for the questions it leaves unanswered. According to Justice Thomas, the Bellingham case did not require the Court to address either (i) whether EBIA had, in fact, consented to the bankruptcy court’s entry of summary judgment on the chapter 7 trustee’s fraudulent transfer claim against it; or (ii) whether parties even have the authority to consent to the bankruptcy court’s entry of a final judgment on a Stern claim. According to Justice Thomas, the Court reserves judgment on those questions “for another day.” As to the latter issue, the Bellingham Court expressly does not address the contention that, because the authority of the bankruptcy courts to enter final judgments implicates the separation of powers in which the structure of the U.S. government is grounded and not simply private rights, litigants lack the power to consent to a bankruptcy court’s entry of a final judgment in a Stern action. Needless to say, Bellingham also leaves open the question of what constitutes valid consent to the bankruptcy court’s entry of a final judgment in a Stern action.

The Court similarly failed to expressly answer the question of whether Congress properly categorized fraudulent transfer claims as core proceedings. Admittedly, the issue was not before the Court. Moreover, as a matter of practice, the courts of appeals and the district courts are generally holding that the adjudication of fraudulent transfer claims cannot be treated as core proceeding. However, some of the language in Bellingham leaves open the argument that fraudulent transfer claims can properly be treated as core proceedings.