SCOTUS in Review: US Supreme Court Bankruptcy Cases 2014-2015 -- Part 2

Yesterday's initial post in this series began with a case from the end of the 2013-1014 term. Executive Benefits v. Arkison effectively peeled back part of the so-called Stern problem created when the Court reiterated that bankruptcy judges, because they don't have the lifetime tenure of federal judges appointed and confirmed under Art. III of the Constitution, cannot exercise the "judicial Power" of the United States. The Court in Executive Benefits pointed to one easy cure for this problem: bankruptcy judges could hear a matter and submit proposed finding of fact and conclusions of law to the federal District Court, which would then, after review, exercise the "judicial Power" and enter judgment.

The first bankruptcy case of the recently-concluded term addressed another solution: consent of the parties to the bankruptcy court's exercise of the "judicial Power." Unlike Executive Benefits, however, the decision in Wellness was fractured. The majority of six carried the day but it was Justice Thomas's dissent that most intrigued me.

Round 2

Less than eleven months after declining to decide whether parties could consent to entry of a final judgment with respect to a Stern claim, the Supreme Court issued it decision in Wellness Int’l Network, Ltd. v. Sharif.[1] Wellness was far from unanimous. Justice Sotomayor wrote the majority opinion in which Justices Ginsburg, Breyer, Kagan, and Kennedy joined. Justice Alito wrote a concurring opinion. The Chief Justice wrote a dissent in which Justice Scalia joined and Justice Thomas joined in part. Justice Thomas went on to write a separate dissent.

Creditor Wellness International, which manufactures health food supplements, contracted with Richard Sharif to distribute its products. The relationship did not go well and Sharif had sued Wellness even before he filed bankruptcy. Sharif resisted Wellness’s efforts to conduct discovery in his action and the district court ultimately entered a default judgment against him, including $650,000 as sanctions for his obstructive efforts. In 2009, Sharif filed for relief under chapter 7 and Wellness filed an adversary action against him. The first four counts of Wellness’s complaint represented various grounds for denying Sharif’s discharge. The fifth count, however, sought a declaration that something called the “Soad Wattar Living Trust” was the alter ego of Sharif and that the trust’s assets should be counted as property of Sharif’s bankruptcy estate.

Sharif admitted that the adversary action was a core proceeding, participated in the action, again failed to submit to discovery requests, and again saw a default judgment entered against him on all five counts, this time by the bankruptcy court. Shortly after Sharif appealed to the district court, the Supreme Court rendered its decision in Stern. Sharif did not, however, raise the issue of whether the alter ego claim of Wellness might be non-core until after the closing of briefing.[2] The district court denied Sharif’s motion to file a supplemental brief and affirmed the bankruptcy court’s judgment.

On appeal, the Seventh Circuit held that the bankruptcy court had jurisdiction to enter final judgment on the dischargeability matters but lacked jurisdiction with respect to the alter ego claim.[3] The Supreme Court granted certiorari and reversed the Seventh Circuit. The majority opinion held first—and non-controversially—that parties may waive their “personal” right to an Article III adjudicator.[4] The majority went on, however, to brush aside the additional separation of powers argument that had animated the majority in Stern. On the one hand,

A litigant’s waiver of his “personal right” to an Article III court is not always dispositive because Article III not only preserves to litigants their interest in an impartial and independent federal adjudication of claims . . ., but also serves as ‘an inseparable element of the constitutional system of checks and balances.’ . . . To the extent that this structural principle is implicated in a given case–but only to that extent–the parties cannot by consent cure the constitutional difficulty . . . .[5]

On the other hand, to resolve the structural separation of powers issue, the majority returned to the multi-factor analysis of a case that antedated Stern by nearly two decades: Commodity Futures Trading Commission v. Schor.[6] The defendant in Stern consistently objected to the bankruptcy court’s exercise of jurisdiction over the counterclaim against him and had certainly not consented to such exercise of jurisdiction, a fact that the majority in Stern noted.[7] Sharif, by contrast, had never resisted bankruptcy court jurisdiction over the alter-ego claim. With what arguably amounted to consent in Wellness, the majority had occasion limit the scope of Stern to its facts.

After canvassing the factors of Schor[8]and applying them to the facts in Wellness, the majority concluded that, with the parties’ consent, a bankruptcy court could constitutionally exercise jurisdiction over a Stern claim. The majority cited four factors in support of its conclusion. First, it observed that bankruptcy judges are appointed and subject to removal by Article III courts. Moreover, bankruptcy judges hear matters solely on reference from the district court (which can withdraw reference at any time). Third, the bankruptcy courts’ power to handle such cases is limited to those related to the underlying bankruptcy case. Finally, the majority concluded that there was no reason to believe that in in granting such jurisdiction to bankruptcy courts Congress had sought to “aggrandize itself or humble the Judiciary.”[9]

Whether Sharif had consented to the jurisdiction of the bankruptcy court was less clear. He had not, in any event, expressly consented to the jurisdiction of the bankruptcy court to enter a final judgment. The lack of express consent was no impediment as far as the majority was concerned; consent could be implied from a party’s conduct.  Nonetheless, such implied consent must be “knowing and voluntary.”[10] Given the record before the Court, the majority declined to decide whether Sharif’s consent could be implied and remanded this issue to the Seventh Circuit.

The dissenters took strong issue with both the majority’s form of analysis and its conclusion. Not surprisingly, the Chief Justice and Justice Scalia believed that the constraints of constitutional separation of powers cannot be overcome by party consent.[11] Of more interest is their straightforward conclusion (in which Justice Thomas joined) that the alter ego claim at issue in this case was not a Stern claim. Since Sharif held legal title to the property of the trust, and specifying what constitutes property of the estate is “peculiarly a bankruptcy power,” the dissenters believed that the majority did not need to address the jurisdictional issue.[12]

Of some interest is the switch of two justices who had been in the majority in Stern. Justice Kennedy did not write separately, but Justice Alito wrote a concurring opinion in which he likened a judgment entered by a bankruptcy judge to “an ordinary, run-of-the-mill arbitration” award for which consent supplies all the constitutional jurisdiction necessary for subsequent entry of judgment. Justice Alito, however, would require express consent as the condition for bankruptcy jurisdiction over Stern claims. Justice Thomas’s dissent presented a substantial reworking of the “public rights” exception to judicial power of Article III and may portend a reconceptualization of this confused area of constitutional law.[13]

At least for now, the combination of Executive Benefits and Wellness has knocked out most of the troublesome issues created by Stern. Parties can consent to the entry of a final judgment by a bankruptcy court in a Stern matter, and even if both parties do not consent—and the district court does not withdraw reference—the bankruptcy court may nonetheless hear the matter and submit proposed finding and conclusions for district court review.

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[1] 135 S.Ct. 1932 (2015).

[2] Wellness’s objections to discharge explicitly fell within the bankruptcy court’s core jurisdiction. 28 U.S.C. § 157(b)(2)(I).

[3] Wellness Int’l Network, Ltd. v. Sharif, 727 F.3d 751, 775–76 (“[The] alter-ego claim is a state-law claim between private parties that is wholly independent of federal bankruptcy law and is not resolved in the claims-allowance process.”).

[4] 135 S.Ct. at 1943 (“[A]s a personal right, Article III’s guarantee of an impartial and independent federal adjudication is subject to waiver ….” (quoting Commodity Futures Trading Com v. Schor, 478 U.S. 833, 848–849 (1986)).

[5] Id. (Citations and internal quotation marks omitted.)

[6] 478 U.S. 833 (1986). While Schor antedated Stern, it came after Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), which set in motion the recurring issue of the jurisdiction of the bankruptcy courts. The ebbs and flows of formal versus functional analyses of Article III’s judicial power make prediction of the results in future cases difficult.

[7] Stern, 564 U.S. at __, 131 S.Ct. at 2594 (where the defendant “‘did not truly consent to’ resolution of the claim against it in a non-Article III forum.”).

[8] The factors on which the majority focused were

the extent to which “the essential attributes of judicial power” are reserved to Article III courts, and, conversely, the extent to which the non-Article III forum exercise the range of jurisdiction and powers normally vested only in Article III courts, the origins and importance of the right to be adjudicated, and the concerns that drove Congress to depart from the requirements of Article III.

Schor, 478 U.S. at 851.

[9] Wellness, 135 S.Ct. at 1944.

[10] The majority describes consent as follows:

A litigant’s consent—whether express or implied—must still be knowing and voluntary. . . . [T]he key inquiry is whether “the litigant or counsel was made aware of the need for consent and the right to refuse it, and still voluntarily appeared to try the case” before the non-Article III adjudicator.

Id. at 1948

[11] Id. at 1954 (“Sharif has no authority to compromise the structural separation of powers or agree to an exercise of judicial power outside Article III.”) (Roberts, C.J., dissenting).

[12] The ease with which the dissenters distinguished the alter ego claim from a fraudulent conveyance claim and concluded that the alter ego claim did not depend on state law is surprising. Id. at 1951–1954.

[13] For a brief analysis of the public rights exception in bankruptcy, see C. Scott Pryor, Who Bears the Burden? The Place for Participation of Municipal Residents in Chapter 9, 37 Camp. L. Rev. 161, 176-80 (2015).