National Bankruptcy Conference Chimes in on Wellness and the Constitutional Validity of Consent

In Wellness International Network Ltd. V. Sharif, a creditor (WIN) sought a finding that a state court judgment against the debtor was non-dischargeable in the debtor’s chapter 7 bankruptcy, and that a trust for which the debtor was the trustee was, in fact, an alter ego of the debtor and therefore liable for his debts. In the bankruptcy court, the debtor failed to respond to discovery requests and court orders and, as a result, the court ordered default judgment to WIN. The debtor appealed to the district court of Illinois and during the pendency of that appeal, the Supreme Court decided Stern v. Marshall. The district court dismissed the debtor’s Stern objection as untimely. At the Seventh Circuit the court found that dischargeability of the debt was a core matter properly decided by the bankruptcy court. The court remanded the alter ego issue to the district court for a determination of whether it was core or noncore and concluded that, if it was core, the bankruptcy court lacked constitutional authority to decide it and the parties could not waive objection to the lack of authority. Wellness International Network Ltd. v. Sharif, 727 F.3d 751, 774 (7th Cir. 2013), cert. granted, 134 S. Ct. 2901 (July 1, 2014) (No. 13-935).

The Supreme Court granted certiorari on two issues:

1. Whether the presence of a subsidiary state property law issue in an 11 U.S.C. § 541 action brought against a debtor to determine whether property in the debtor’s possession is 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.
2. Whether Article III permits the exercise of the judicial power of the United States by the bankruptcy courts on the basis of litigant consent, and, if so, whether implied consent based on a litigant’s conduct is sufficient to satisfy Article III.

In a two-part report, the National Bankruptcy Conference addresses the issues raised in this case.

Jonathan M. Landers and Brady C. Williamson reported on the first issue. “Wellness and other lower court decisions have analyzed the boundaries of Stern claims in terms of (1) whether the claim arose under bankruptcy law or state law; (2) whether the claim could involve private parties outside of bankruptcy; (3) whether the claim was brought to augment the bankrupt estate; and (4) whether the claim stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process. Since Stern, courts have construed many matters that Congress had deemed core under § 157(b) to be beyond the adjudicatory authority of bankruptcy judges, thus becoming so-called Stern claims.”

As a result of the holding in Stern, Landers and Williamson say, litigation is often delayed while parties struggle over whether a bankruptcy court has jurisdiction over some or all of a claim and if it does not, how the case must be disaggregated. Judges may act defensively, writing proposed findings of fact and conclusions of law, rather than deciding issues they would previously have entered final judgment on. Delays while counterclaims are separately determined may result in loss of estate property merely because the trustee may not pursue it.

Because the issue involves constitutional authority, it may be raised even after a great deal of time and costs have accrued in the case, sometimes not being raised until the case is on appeal. The authors suggest that practical considerations such as costs to the judicial system should be part of the Supreme Court’s analysis in Wellness.

Landers and Williamson conclude: “The Seventh Circuit’s decision in Wellness should be reversed. The Supreme Court should reiterate that its ruling in Stern was sharply limited, and it should provide more guidance for courts to identify a small subset of claims that Congress considered core but go beyond the bankruptcy court’s adjudicatory authority. Most importantly, the Court should make it clear that, just as § 157 provides, the fact a dispute is governed or affected in whole or part by state law is not determinative. See 28 U.S.C. § 157(b)(3).”

1. Elizabeth Gibson took on the second issue for which the Supreme Court granted cert.: whether a litigant should be able to consent to authority of the bankruptcy court to adjudicate a Stern claim. Gibson notes that if the Supreme Court finds that a litigant can effectively waive the right to Article III adjudication, many of the concerns raised by Landers and Williamson would be minimized. She raises several references by the Supreme Court that suggest that the Court assumes that the right to an Article III adjudication may be waived, including an apparently approving reference in Stern to the consent provision of section 157(c)(2).

Gibson discusses the Supreme Court case of Commodity Futures Trading Commission v. Schor, 478 U.S. 833 (1986), which involved adjudication of a common law counterclaim by an administrative agency, as providing a framework for assessing the effect of consent to non-Article III adjudication. Schor distinguished between Article III’s protection of individual rights, which could be waived, and Article III’s protection of structural interests which could not be waived by consent of the parties.

To determine whether a structural interest is at stake, the Schor Court provided the following benchmarks: 1) The extent to which the essential attributes of judicial power are reserved to Article III courts, 2) The origins and importance of the right to be adjudicated. Specifically, whether the claim was a public or private right and whether it was governed by state or federal law, 3) The concerns that drove Congress to depart from the requirements of Article III, i.e. whether the intrusion on the federal judiciary was de minimus.

Applying the Schor factors to section 157(c)’s consent provision, Gibson argues that ultimate authority over bankruptcy judges remains with the Article III district courts. Where “Congress sought to maintain an effective bankruptcy system with specialized courts capable of handling the bankruptcy caseload in a timely manner, while at the same time leaving sufficient power in the Article III courts to preserve judicial independence,” the factors in Schor favor consent. Gibson concludes that “[w]hen the entirety of this legislative scheme for bankruptcy adjudication is taken into account, the analysis prescribed by Schor leads to the conclusion that party consent eliminates constitutional objections to the entry of a judgment by a bankruptcy judge.”

Wellness is set for argument on Wed. January 14.

NBC Wellness report December 2014