From a Scream to a Whisper: The Supreme Court Does Little to Fix Its Bankruptcy Court Mess (Executive Benefits Insurance Agency v. Arkison (In re Bellingham))
Jonathan C. Lipson*
Oh it’s not easy to resist temptation
Walking around looking like a figment of somebody else’s imagination1
Say what you will about Justice Clarence Thomas: unlike the protagonist in Elvis Costello’s paean to libidinal frustration, 2 his unanimous opinion in Executive Benefits Insurance Agency v. Arkison (In re Bellingham), 3 certainly resists many temptations left by its predecessor, Stern v. Marshall, 4 to define what bankruptcy courts can and cannot do. Rather than take on Stern’s grand systemic concerns—the nature of the Article III “judicial power” 5—Bellingham whimpers out on a technicality, concluding that problems created by Stern can be statutorily “severed” and thus resolved with the slice of a judicial knife. 6
Some observers believe that Bellingham has “swept aside” the problems created by Stern. 7 Others are not so sanguine and worry that the “expense and delay” of litigating Stern questions will continue to burden a bankruptcy system ill-suited to absorb these costs. 8 If we recognize that Stern presented two types of uncertainties—(1) about its scope, and (2) about the process for resolving so-called “Stern” claims—it would appear that there is some merit to both views, although concerns about expense and delay have the upper hand.
Bellingham largely addresses the second uncertainty—process—and will thus reduce litigation costs to some extent. Nevertheless, it locks in a systemic redundancy that would appear to raise costs permanently by requiring “de novo” district court review of Stern claims. 9 More important, it fails to tell us what is within Stern’s scope to begin with. Worst of all, its characterization of the particular type of claim involved—a fraudulent transfer—as a “private” cause of action may be wrong, with important efficiency implications for the bankruptcy system.
Although Bellingham ignores the most important questions raised by Stern, there is cause for hope. Shortly after the Court announced its decision in Bellingham, it granted a petition for a writ of certiorari in Wellness International Network, Ltd. v. Sharif, 10 where it has agreed to consider some of the questions left by Stern, in particular whether parties can (be deemed to) consent to bankruptcy court adjudication. 11
This essay briefly summarizes the problems created by Stern and five ways in which Bellingham failed to fix them.
I. Stern/Bellingham Redux
For those late to the show, Stern said that a certain class of claims in a bankruptcy case could not be adjudicated by Article I bankruptcy judges because those judges depend upon Congress for their jobs and salaries. 12 Giving them the “Article III judicial power” threatened the separation of powers created by the Constitution. 13 Thus, Stern was framed as a problem about how much “judging” bankruptcy judges could do without encroaching on Article III (“constitutional”) courts.
Since its creation in 1978, there have been questions about this at the margins. Article I courts are created by Congress, 14 and their powers are limited both by the mandate Congress gives them (here under bankruptcy law), as well as the structure of separated powers envisioned by the Constitution. Ordinarily, and absent an exception, Article I courts cannot exercise the “Article III judicial power.” Although the boundaries of this power are not clear, Stern was adamant that it included the power to adjudicate “private” “common law” suits as understood in Westminster, England in 1789. 15 This presented a problem for bankruptcy courts, because much of what I have called the “ordinary work of bankruptcy courts” 16 involves adjudicating private common law disputes over such things as the allowance or disallowance of claims, the recognition and enforcement of liens, and so on.
In Stern, the litigation was not the “ordinary work” of bankruptcy courts. It involved a “tortious interference with an expected gift” counterclaim that a debtor’s estate asserted against a creditor. 17 On pragmatic grounds, the matter should have been left to courts of general jurisdiction (in particular, the state court that had the underlying, original action). But Congress had created a list of things that it considered at the “core” of bankruptcy courts’ power. 18 This list included counterclaims held against creditors, 19 which was technically the case in Stern.
Stern recognized that bankruptcy courts could adjudicate “private” “common law” disputes if the adjudication was part of the “claims allowance process” 20 (in Stern, the Court decided, confusingly, that it was not). But the Court did not tell us what that phrase meant, or the fate of two other theories on which bankruptcy court authority might have been sustained: (1) party “consent,” and (2) the so-called “public right” doctrine announced in the 19th century case, Murray’s Lessee v. Hoboken Land & Improvement Co. 21 Nor did Stern provide guidance on how courts should deal with so-called Stern claims—those that were statutorily “core” but nevertheless constitutionally impermissible.
Intuitively, one might think that Stern claims should simply go to the court of general jurisdiction that would otherwise adjudicate the dispute (e.g., a U.S. district court if there is diversity of citizenship). The problem is that the bankruptcy process does not work this way. While original jurisdiction of bankruptcy matters is vested in U.S. district courts 22—not bankruptcy courts—they have shown little interest in this work. They have thus used their power to “refer” most bankruptcy matters to bankruptcy courts. 23 If a matter was statutorily “core” and referred to a bankruptcy court, then a district court would have only appellate jurisdiction over it: it could not adjudicate it “de novo.” 24
Thus, Stern left a procedural “gap”: the Supreme Court had said that bankruptcy courts lacked the power to adjudicate an (indeterminate) class of disputes, but there was no process for resolving them if one took the bankruptcy rules at face value. 25 The net result of Stern was an extraordinary amount of litigation over its meaning and implications. Because those in bankruptcy are usually broke, spending money to litigate these questions is especially troubling: bankruptcy was designed to promote settlements, not full blown litigations over constitutional niceties of little relevance to the ordinary operation of the system.
II. Stern’s Bellwether—Fraudulent Transfer
An important class of Stern claims involves suits to avoid fraudulent transfers. A fraudulent transfer is any transfer (which includes a debt or lien) for less than “reasonably equivalent value,” where the transferor-debtor is (or is rendered) financially distressed (e.g., insolvent). 26 Until Stern, there was little question that bankruptcy courts could adjudicate such suits because they were “core” matters on the list of “ordinary bankruptcy work” created by Congress. 27 In most cases, there was no constitutional problem because the defendants would also be creditors, and so the litigation could be viewed as part of the “claims allowance process.”
Problems could arise, however, if the trustee sued defendants who were not creditors—such as the selling shareholdings in a failed leveraged buyout or net takers in a Ponzi scheme—because the suit could not be resolved in the “claims allowance process.” This derived from the Supreme Court’s 1989 decision in Granfinanciera, S.A. v. Nordberg, 28 where the Court held that a defendant in a fraudulent transfer suit who had not filed a claim in the debtor’s bankruptcy had a right to a jury trial. 29 Congress thereafter dealt with this by providing that in such cases, district courts—not bankruptcy courts—should hold such jury trials. This has been the practice ever since. Bankruptcy courts could still enter dispositive motions—summary judgment, for example, as happened in Bellingham—prior to trial; but the jury, if any, would be empanelled by the district court. 30
After Stern, courts split over whether bankruptcy courts retained the power to adjudicate fraudulent transfers. This was due principally to dicta in Granfinanciera, where Justice Brennan’s majority opinion said that a fraudulent transfer suit was “quintessentially [a] suit at common law that more nearly resemble[d] state-law contract claims.” 31 Because Stern had echoed this language, and Granfinanciera involved a fraudulent transfer, many thought this meant that fraudulent transfer suits were “Stern” claims. 32 Others disagreed. 33
III. I Don’t Want to Go to Bellingham
Which takes us to Bellingham. This was a classic, somewhat seedy fraudulent transfer: the owner of two corporations transferred, without consideration, assets from one, which was in trouble (Bellingham), to the other, which was not. 34 He then put Bellingham into bankruptcy. 35 Bellingham’s bankruptcy trustee sued to avoid the allegedly fraudulent transfer. 36 The trustee won summary judgment in the bankruptcy court, from which the defendants appealed to a U.S. district court. 37 After a de novo review (note: this is important), it affirmed. 38
Since there was no real question about merit—the defendant clearly engaged in a fraudulent transfer—the important defenses were procedural; in particular, whether the defendant had “consented” to bankruptcy court adjudication. 39 “Because [the defendant] waited so long to object, and in light of its litigation tactics,” the Ninth Circuit observed, “we have little difficulty concluding that [the defendant] impliedly consented to the bankruptcy court’s jurisdiction.” 40 Alternatively, the court of appeals upheld summary judgment because the district court had affirmed the bankruptcy court’s adjudication following “de novo” review. 41
Bellingham was considered important because many expected the Court to indicate whether (or to what extent) Stern affected the capacity to “consent” to an Article I adjudication. “Consent” in this context presents a complex and difficult question, with implications far beyond the bankruptcy system. There are thousands of Article I judges—think of tax courts, administrative law judges, magistrates—whose work often depends on parties consenting to their authority. If, as the defendants in Bellingham argued, parties could not consent to an Article I adjudication, the Stern problem would spill into fields well beyond bankruptcy. Thus, many assumed that the Court agreed to hear Bellingham to provide guidance on this issue. 42
IV. “No Action”
They were wrong.
Rather than tell us anything about the role that consent plays in the scope of bankruptcy court power, the Supreme Court looked to the rules of bankruptcy procedure. Because the enacting legislation contained a severability provision, 43 the Court concluded that it could excise those provisions of the rules of procedure that permit a bankruptcy court to fully adjudicate a fraudulent transfer suit as a “core” matter. 44 “The plain text of this severability provision closes the so-called ‘gap’ created by Stern claims,” Justice Thomas explained. 45 “When a court identifies a claim as a Stern claim, it has necessarily ‘held invalid’ the ‘application’ of § 157(b)—i.e., the ‘core’ label and its attendant procedures—to the litigant’s claim.” 46
V. From a Scream to a Whisper
Does Bellingham “close the Stern gap,” as Justice Thomas promised, silencing the din of litigation over every aspect of Stern’s meaning and implications?
Probably not, for at least five reasons.
First, it is not entirely clear that “severability” alone is enough. To say that a Stern claim is no longer statutorily “core” is only half the battle. One must still find something affirmative in the statute indicating what becomes of that claim. The bankruptcy process does not do this directly. Instead, as noted above, district courts may refer bankruptcy matters to bankruptcy courts. Presumably, after Bellingham, U.S. district courts will amend their local referral rules to affirmatively provide that Stern claims will be treated as they were in Bellingham: they will be adjudicated provisionally by the bankruptcy judge, who will produce “proposed findings of fact and conclusions of law,” subject to de novo review by the district court. But, this may require amendments to local rules, which may not be forthcoming.
Second, Bellingham tells us how to resolve Stern claims, but does not tell us what those claims are. Indeed, Justice Thomas merely “assume[s] without deciding that the fraudulent conveyance claims in this case are Stern claims.” 47 It appears he made this assumption because “the fraudulent conveyance claims in this case are ‘not . . . core.’ The Ninth Circuit held—and no party disputes—that Article III does not permit these claims to be treated as ‘core.’” 48
This is true, but not for the reasons he seems to assume. Fraudulent transfer suits are clearly “core” as a statutory matter. 49 Here, however, the defendants in Bellingham had sought to withdraw the reference in order to have a jury trial. 50 As noted above, if a defendant seeks a jury trial in a fraudulent transfer suit, it is likely to end up in the district court, meaning that it will not be treated as core. But that is because of special rules and concerns about jury trials expressed by Granfinanciera, not because fraudulent transfer claims are not “core.” Indeed, the whole problem created by Stern was that it created a mismatch between what Congress said was “core” and what the Court said bankruptcy courts could treat as core. If the fraudulent transfer suit in Bellingham was not core, there would have been no Stern problem to begin with.
This reflects a more general tendency of the Court to conflate the right to a jury trial and the scope of the Article III judicial power. The conflation is a problem because it perpetuates a mistaken understanding of the nature of fraudulent transfer suits; in particular, that a fraudulent transfer suit is a matter of “private right” for Article III purposes. According to Justice Thomas, the Supreme Court in Granfinanciera “held that a fraudulent conveyance claim under Title 11 is not a matter of ‘public right’ for purposes of Article III.” 51
This is questionable. As I (and others) have explained elsewhere, 52 the decision in Granfinanciera may tell us something about the right to a jury trial in bankruptcy, but its discussion of the “public” or “private” character of a fraudulent transfer suit for Article III—judicial power—purposes is dicta, as it simply was not an issue in that case. 53 Indeed, fraudulent transfer suits have historically had important public qualities: when brought as part of a bankruptcy case, they are probably more “public” than “private.” 54 Among other things, the fraudulent transfer cause of action was created by the English Parliament—not by the common law—in the 16th Century Statute of Elizabeth. 55 Although fraudulent transfer law came to permit private creditor suits, it was initially intended in large (perhaps most) part to benefit the Crown, which used it to penalize religious dissenters and to raise revenue (the Crown got half of any recovery). 56 By the framing era, a fraudulent transfer was an “act of bankruptcy,” which in England carried criminal penalties. 57 Contrary to Justice Brennan’s majority opinion in Granfinanciera (echoed by Chief Justice Roberts in Stern), a fraudulent transfer suit was not “quintessentially [a] suit at common law that more nearly resemble[d] state-law contract claims.” 58 Rather, it was (and remains) a second-order remedy that solves significant collective action—that is, public—problems.
This matters because if a fraudulent transfer suit involves a “public right” for Article III purposes, then well-established precedent (e.g., Murray’s Lessee, noted above) suggests that bankruptcy courts do have the constitutional authority to adjudicate them if Congress so provides. Recognizing this would not only comport with the historical character of fraudulent transfer suits, but would also create important efficiencies, because it would avoid fights over the role that “consent” may (or may not) play in this arena.
Which is the third problem Bellingham leaves us: it tells us nothing about the role that consent plays in bankruptcy (and thus other Article I) disputes. 59 Is consent an alternative to the severability/de-novo review strategy it seems to promote? If so, what conduct shows it: The indolence of the lawyers in Bellingham, who waited to raise the constitutional issue until after briefing in the court of appeals? Or must courts find something more formal, akin to an arbitration clause? If consent is not a basis for bankruptcy court adjudication, is that because it is structurally impermissible—that is, parties cannot consent to an Article I adjudication, ever, as the Bellingham defense argued?
At this point, we do not know. But, we may soon. A few weeks after deciding Bellingham, the Court granted a petition for a writ of certiorari in Sharif, a case from the Seventh Circuit Court of Appeals, which held that “a constitutional objection based on Stern is not waivable because it implicates separation-of-powers principles.” 60 By granting Sharif, the Court has agreed to consider, among other things, “[w]hether 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.” 61
Until we know more about consent, we can expect that Stern claims—whatever they may be—will in most cases now go to U.S. district courts for de novo review, which leads to a fourth problem: Bellingham locks in a needless layer of added cost. Prior to Bellingham, Bankruptcy Judge Joan Feeney had argued that this approach “would only add permanence and legitimacy to the current problem inherent in the bankruptcy system, namely that litigants need to visit both the bankruptcy court and district court to resolve their disputes.” 62 She is right. As Congressman Peter Rodino explained over thirty years ago, “One of the major reasons for the separate bankruptcy court, which has long been in existence, is the need for expedition in bankruptcy cases.” 63
This, then, bespeaks the fifth problem: whether the Court could “sever” the rules of bankruptcy procedure to “fill” the Stern gap depended on whether the Bankruptcy Code would “remain ‘fully operative as a law’” despite the severance. 64 The Court unanimously believed that it would, and most would not seriously claim otherwise. It is nevertheless important to remember that bankruptcy is meant to be a pragmatic process where speed and efficiency are at a premium. As legislative history explains:
In establishing the bankruptcy judicial system for the Nation, two considerations must be paramount: (1) judicial economy and efficiency and (2) constitutionality. The bankruptcy court system must provide judicial services at a high level of efficiency and competence, and, at the same time, must meet the requirements of the Constitution. 65
Bankruptcy lawyers are highly sensitized to issues of “priority” and so will note immediately that the first consideration is efficiency; constitutionality is second and (by inference) subordinate. Stern and Bellingham get this backwards, and leave a bankruptcy system with what appears to be permanently higher costs in the service of ill-defined constitutional values. To the extent one believes that judicial economy and efficiency are central to the bankruptcy process, perhaps Bellingham’s “severability” tactic will not leave the Bankruptcy Code “fully operative” after all.
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In a Supreme Court term marked by near-operatic howling over campaign finance and the religious liberty rights of corporations, a decision as pithy and technical as Bellingham is likely to be ignored by all but aficionados. This is unfortunate. The operation of the bankruptcy system affects all of us. The more it costs to operate that system, the less effective it will be. Bellingham will keep its costs artificially high for some time. This is nothing to sing about. Let us hope that in Sharif the Court in its next term offers more than lip service and better defines the scope of bankruptcy court power.