Constitutional Authority Objection Not Waivable

In Stern v. Marshall, 131 S. Ct. 2594 (2011), the Supreme Court established that a bankruptcy court lacks constitutional authority to enter a final judgment on a debtor’s state law counterclaim despite Congress’s grant of statutory authority to do so. In Wellness Int’l Network v. Sharif, No 12-1349 (7th Cir. Aug 21, 2013), the seventh circuit held that a constitutional objection based on Stern is not waivable.

The debtor, Sharif, was sanctioned in the amount of $ 650,000.00 for his conduct in a civil case in a district court in Texas. He later filed a chapter 7 bankruptcy petition in the Northern District of Illinois. The judgment creditor from the Texas case filed a five count adversary proceeding, the first four counts of which sought an order of nondischargeability under section 727. The fifth count sought declaratory judgment that the Trust for which the debtor was trustee was debtor’s alter ego and that its assets should be included in the debtor’s bankruptcy estate.

As was apparently his modus operandi, the debtor failed to comply with discovery in connection with the adversary complaint and the bankruptcy court entered a default judgment against him. The debtor appealed to district court. Subsequent to the bankruptcy judgment but prior to briefing on appeal, the Supreme Court decided Stern v. Marshall. The debtor did not cite Stern in his brief on appeal. Later, the debtor sought to file a supplemental brief seeking dismissal of the appeal based on Stern. The district court held that, by failing to raise Stern earlier, the debtor had waived the issue. It affirmed the bankruptcy court’s judgment.

The seventh circuit, after finding that all five claims either fell under the bankruptcy court’s statutory authority or that objection on that basis was properly waived, turned to the question of whether the bankruptcy court had constitutional authority over the claims. Under Stern, a bankruptcy court, as a non-Article III tribunal, does not have constitutional authority to enter final judgment on a state law claim that does not involve “public rights” or stem from a federal statutory scheme. Quickly disposing of the first four claims as stemming from federal bankruptcy law and therefore being within the purview of the bankruptcy court’s constitution authority, the court focused on the alter-ego claim. That claim, it found, does not involve “public rights,” but is one for which state law provides the rule of decision. It concluded, therefore, that the bankruptcy judge lacked constitutional authority to enter a final judgment on the alter‐ego claim.

As to whether the debtor could waive his objection to the court’s authority, the court noted that there is a split in the circuits. See In re Bellingham Ins. Agency, Inc., 702 F.3d 553, 566–70 (9th Cir. 2012) (waivable), cert. granted, 133 S. Ct. 2880 (2013) (No. 12–1200); Waldman v. Stone, 698 F.3d 910, 917–18 (6th Cir. 2012) (not waivable), cert. denied, 133 S. Ct. 1604 (2013). Although the Supreme Court is poised to address the issue next term, the seventh circuit panel found there was no reason to delay its decision as “the path to resolution of that issue is sufficiently clear.”

The court, rejected the debtor’s claim that the matter was one of subject-matter jurisdiction that could be raised at any time in the course of litigation or appeal and could not be waived. Rather, the bankruptcy court’s authority or lack thereof, rests on interpretation of Article III § 1 which has the dual components of a waivable personal safeguard and a non-waivable structural safeguard. Therefore, the court found that it is at least possible to consent to a bankruptcy court’s authority under section 1 of Article III. Citing Commodity Futures Trading Comm’n v. Schor, 478 U.S. 833, 848–57 (1986) (de minimis intrusion on judicial branch does not preclude waiver).

In In re Bellingham Ins. Agency, Inc., the ninth circuit found that “the allocation of authority between bankruptcy courts and district courts does not implicate structural interests, because bankruptcy judges are ‘officer[s] of’ the district court and are appointed by the Courts of Appeals.” In contrast, the sixth circuit in Waldman v. Stone, 698 F.3d 910 (6th Cir. 2012), held that an objection based on the bankruptcy court’s constitutional authority could not be waived because it necessarily implicates both personal and structural safeguards. The seventh circuit agreed with the sixth circuit, finding that: “a constitutional objection based on Stern is not waivable because it implicates separation‐of‐powers principles.”

Applying that finding to the case before it, the court upheld the district court’s affirmance of the bankruptcy court’s judgment as to the first four claims, and reversed and remanded the case with respect to the fifth count of the adversary complaint.

[In addition to presenting the issue of waiver, Bellingham raises the question of whether a bankruptcy court can submit proposed findings of fact and conclusions of law in a core proceeding despite 28 U.S.C. § 157(c)(1)’s specific reference to non-core proceedings.]

Sharif opinion