Pennsylvania Court Bucks Third Circuit Trend In Ruling That Bankruptcy Courts Lack Authority to Issue Final Order in Fraudulent Transfer Lawsuits

In a departure from other bankruptcy courts in the Third Circuit and her own recent prior opinion, U.S. Bankruptcy Chief Judge Mary France of the Middle District of Pennsylvania broadly interpreted the U.S. Supreme Court’s ruling in Stern v. Marshall, 564 U.S. 2 (2011), and held that a bankruptcy court lacks the constitutional authority to issue a final judgment in any fraudulent transfer action where the defendant (i) has not filed a proof of claim and (ii) has not consented to the bankruptcy judge entering a final judgment on the matter. 

As reported in our previous published issues of Absolute Priority, the U.S. Supreme Court’s decision in Stern provided that a bankruptcy judge did not possess the constitutional authority to enter a final judgment on a state law counterclaim despite such claims being specifically identified as “core” proceedings that may be determined by bankruptcy judges.  Stern has predictably spawned countless challenges to the authority of bankruptcy courts to rule on a broad range of bankruptcy matters, including fraud claims, and has resulted in a growing body of case law that grapples with precisely how broadly Stern should be applied in contexts that were not explicitly addressed by the Supreme Court.   

            Decisions rendered by bankruptcy courts in Delaware and the Western District of Pennsylvania, sister districts in the Third Circuit to the district over which Judge France presides, have interpreted Stern narrowly, concluding that bankruptcy courts continue to possess the constitutional authority to enter final orders in most core matters because Stern addressed only the specific and circumscribed issue of the court’s power to adjudicate a trustee’s common law counterclaims against a creditor.  Until recently, Judge France shared this view, stating just last year that she was “inclined to follow those courts which have concluded that Stern was decided narrowly and should have a limited impact on a bankruptcy court’s authority to enter a final judgment on a matter.”  Black, Davis and Shue Agency, Inc. v. Frontier Insurance Co. in Rehabilitation (In re Black, Davis and Shue Agency, Inc.), 471 B.R. 381, 401 (Bankr. M.D. Pa. 2012).  Courts in other jurisdictions, most notably in the Ninth Circuit, have articulated a different view, holding that Stern precludes bankruptcy judges from issuing final rulings in a host of disputes that are traditionally the province of U.S. district courts.    

            Judge France revisited the issue this past summer in Carr v. Loeser, et al. (In re International Auction and Appraisal Services LLC), 2013 WL 2420844 (Bankr. M.D. Pa. 2013).  In that case, a chapter 7 trustee commenced an avoidance action against the debtor’s sole member and his spouse, who filed a motion to dismiss the action under Stern.  Neither party disputed that the trustee’s fraudulent conveyance claims were “core” or that the bankruptcy court had statutory authority to hear and determine the claims.  The only issues before the court was whether it had the constitutional authority to enter a final judgment on the fraudulent transfer claims, and the impact of the defendants’ failure to file a proof of claim or consent to the bankruptcy court’s adjudication of the dispute on that analysis.  In light of the narrow interpretation of Stern previously applied by Judge France and other Third Circuit courts, the weight of authority appeared to lean heavily in favor of the trustee.  Nonetheless, in a surprise decision, the court ruled for the defendants, concluding that it could not enter a final order in the matter.   

 

            Judge France observed that, under Stern, if (i) a defendant in an adversary proceeding did not expressly consent to the bankruptcy court’s consideration of the cause of action and (ii) the claims allowance process is not implicated by the dispute, then the bankruptcy court may only issue a final order if the matter falls within the “public rights exception,” a common law doctrine that permits bankruptcy courts to enter final orders in disputes involving private rights if those rights are closely integrated into a public regulatory scheme like the Bankruptcy Code.  In analyzing whether the public rights exception applied, the court determined that Stern provided “if not unequivocal, then at least conclusive” authority that the right to recover fraudulent transfers is a private, not public, right.  Notably, in support of her conclusion, Judge France approvingly cited In re Bellingham Ins. Agency, Inc., 702 F.3d 553 (9th Cir. 2012), the Ninth Circuit’s seminal decision in favor of the type of broad interpretation of Stern previously rejected by Judge France and other Third Circuit Courts. In adopting the reasoning of Bellingham and disavowing her prior ruling, Judge France explained that, while a narrow construction of Stern may be appropriate in “some circumstances,” there is no support for an argument that the public rights exception applied to fraudulent transfer claims and declared that Stern now must be read to preclude a bankruptcy court from entering a final judgment in fraudulent transfer actions. 

 

            Judge France’s evolving position over a brief period of time regarding the proper scope of Stern illustrates the extent to which uncertainty continues to reign over the field of bankruptcy litigation in the aftermath of the Supreme Court’s ruling.  Although the Supreme Court has agreed to revisit this issue when the Bellingham case comes before it sometime next year, this confusion is likely to continue well into 2014, as new decisions are issued and conflicting opinions proliferate from courts throughout the country.  Hopefully, the Supreme Court will use its consideration of Bellingham to provide some much-needed clarity regarding the scope of the constitutional power of bankruptcy courts.  In the interim, fraudulent conveyance actions commenced in bankruptcy cases will have a cloud hanging over them, and a procedural morass will persist that may enable parties to employ litigation tactics to slow the resolution of  these claims.    

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