U.S. Supreme Court Affirms Bankruptcy Judges' authority

NEW YORK (The Deal) -- The U.S. Supreme Court has handed down a decision that affirms that bankruptcy judges can have the final say in their cases.

The court ruled 6-3 Tuesday that bankruptcy judges could adjudicate certain claims in cases with the parties' consent. In the opinion, Justice Sonia Sotomayor wrote, "It is no exaggeration to say that without the distinguished service of these judicial colleagues [magistrate and bankruptcy judges], the work of the federal court system would grind nearly to a halt."

The ruling, which had been pending since oral arguments on Jan. 14, determined whether a state property law issue in a lawsuit questioning the "property of the bankruptcy estate means that such action does not 'stem from the bankruptcy itself' and therefore, that a bankruptcy court does not have the constitutional authority to enter a final order deciding that action."

Bankruptcy judges are appointed under Article I of the Constitution, a different statute than Article III, which governs district and appeals court judges. The former have 14-year terms, whereas the latter have life tenure. The Bankruptcy Amendments and Federal Judgeship Act of 1984 established core proceedings that could be handled to conclusion in bankruptcy court.

In the opinion, Sotomayor wrote Article III is not violated when the parties "knowingly and voluntarily consent to adjudication by a bankruptcy judge." Cases in which the Supreme Court has found a violation of a litigant's right to an Article III decision maker have all "involved an objecting defendant forced to litigate voluntarily before a non-Article III court."

Sotomayor contended the court has never held a litigant who has the right to an Article III court may not waive that right through his or her consent.

Sotomayor concluded: "To hear the principal dissent [Chief Justice John G. Roberts and Justices Antonin Scalia and Clarence Thomas] tell it, the world will not end in fire, or ice, but in a bankruptcy court. ... Adjudication based on litigant consent has been a consistent feature of the federal court system since its inception. Reaffirming that unremarkable fact, we are confident, poses no great threat to anyone's birthrights, constitutional or otherwise."

The Wellness decision once again addressed issues first raised in the court's Stern v. Marshall ruling on June 23, 2011, and revisited in last year's Executive Benefits Insurance Agency v. Arkison decision.

The case began when Richard Sharif entered into a distribution contract with Wellness, a Plano, Texas, nutritional product company, for the sale of health and wellness products. He later sued the company, alleging it was perpetrating a pyramid scheme.

Ultimately, a district court granted summary judgment against Sharif and awarded the company $655,596 in legal fees as a sanction for Sharif ignoring discovery requests.

Wellness has tried to discover Sharif's assets, but the company alleged he ignored all attempts until he was held in civil contempt and ultimately arrested.

Sharif subsequently filed a Chapter 7 petition, and Wellness alleged in the proceedings that Sharif had hid property. The bankruptcy court sided with Wellness and ordered Sharif to pay Wellness' attorneys' fees, as well as some other sanctions.

As Sharif was appealing to a district court, the Supreme Court made a decision in the much-cited Stern v. Marshall case.

In that ruling, the Supreme Court found bankruptcy judges, as they are not covered by Article III, did not have the authority to enter a final order on a state law counterclaim not resolved in the process of ruling on a creditor's proof of claim. The case stemmed from a probate battle over the estate of J. Howard Marshall II that spilled into the bankruptcy of Marshall's now-deceased widow, Vickie Lynn, better known as former Playmate Anna Nicole Smith.

The majority decision authored by Roberts found a counterclaim for alleged defamation from Marshall's son in the bankruptcy was a core proceeding but that bankruptcy judges lacked the constitutional authority to enter a judgment on the counterclaim.

The EBIA case clarified that while the nation's bankruptcy judges can submit proposed findings of fact and conclusions of law for certain summary judgments, the power to finalize such judgments will reside with district court judges. It did not, however, resolve the question--decided in the latest ruling--of whether parties could consent to a bankruptcy judge entering a final order rather than having the district court issue the final ruling.

Sharif tried to argue his case based on Stern but was blocked by the district court, which ruled that objections of that type could be waived and that Sharif's failure to bring up any argument earlier was implied acceptance. The U.S. Court of Appeals for the 7th Circuit ultimately ruled an objection based on Stern could not be waived and that the bankruptcy court only had the authority to enter a final judgment on some of Wellness' claims, teeing up the current Supreme Court case. Wellness on Feb. 5, 2014, petitioned the court for a writ of certiorari, which was granted on July 1.

In a Tuesday statement, G. Eric Brunstad Jr., a bankruptcy partner at Dechert LLP who was counsel of record for the Marshall family in that case, said, "In its decision in Wellness, the Supreme Court today concluded that, with litigant consent, a bankruptcy judge may finally decide a controversy that without such consent would ordinarily have to be decided in federal court by an Article III judge.

"This is a tremendously important decision for the administration of not only bankruptcy cases, but also other litigation in federal court before magistrate judges. ... The question the court resolved today is whether, with the consent of the parties, a non-Article III bankruptcy judge may decide such a claim, and whether the litigant's consent need be express, written consent.

"The Supreme Court determined that a litigant may consent to have a bankruptcy judge decide the claim and that the litigant's consent need not be express, but must simply be knowing and voluntary. This decision is vitally important because it clarifies the bankruptcy judge's authority to decide a broad variety of matters brought in the federal bankruptcy courts. It is also vitally important because, by extension, it clarifies the authority that federal magistrate judges have to decide a broad variety of matters based on the litigants' consent. The current bankruptcy jurisdictional system was patterned after the system in place for magistrate judges. The decision goes a long way in preserving the basic statutory distribution of authority between bankruptcy judges and other federal judges."

Richard Mikels, chair of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC's bankruptcy, restructuring and commercial law practice, said the decision "creates certainty where previously there was uncertainty." Exactly what that "knowing and voluntary consent" will mean, however, Mikels said, is going to have to be determined on a case-by-case basis going forward.

He said this latest ruling skews pretty close to the law that existed before the Bankruptcy Code was enacted in 1978, adding that "those precedents will [likely] be fairly helpful" in making decisions on this matter going forward.

Mikels said the danger of the decision going the other way was "uncertain delay."

"The more expeditious a bankruptcy is, the better for the parties," he said, pointing out that if you're a creditor waiting for a dividend in a bankruptcy case, the quicker the case is wrapped up, the faster you will get your recovery.

Mikels said an interesting aspect of the situation to watch going forward is the determination of what is a "Stern claim" and what is not. A Stern claim, Mikels said, is a claim related to a bankruptcy case that independent of the bankruptcy would have an impact on the proceeding. (An example is the return of goods or property that may have been fraudulently conveyed.)

The opinion did not address the question, though, instead focusing in on the issue of consent.

Wellness counsel Catherine Steege of Jenner & Block LLP said, "We're very pleased with the court's ruling, and the court clarified an issue that is extremely important to both the bankruptcy courts and the federal courts as whole."

Steege added the court's ruling would eliminate litigation and would prevent a case from proceeding all the way to a ruling by a bankruptcy judge, only to have a party disagree with a decision.

"It avoids sandbagging that could occur by parties that don't like the outcome," she said.

Counsel to Sharif, Jonathan D. Hacker of O'Melveny & Myers LLP, also found positives in the ruling.

"We're encouraged by the opening that the court left us on remand," Hacker said.  "We were pleased that the court was not persuaded by the other side's arguments to hold that it was not a Stern claim, and by focusing on consent, the court gave us the opportunity we needed to pursue the issue further in the lower courts."

The issue has been remanded to the 7th Circuit, where Sharif will make the argument about the lack of consent, Hacker said.

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