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U.S. Supreme Court Limits the Powers of the Nation’s Bankruptcy Courts

Bankruptcy Alert | June 10, 2014
By: Earl M. Forte

On June 9, 2014, the Supreme Court of the United States issued its much-awaited decision in Executive Benefits Insurance Agency v. Arkison, Chapter 7 Trustee of Estate of Bellingham Insurance Agency, Inc., Case No. 12-1200, in which the court confirmed that the power of the nation’s bankruptcy courts to hear and decide cases involving state-created private rights in which the bankruptcy proof of claim process has not been directly invoked, is severely limited by Article III of the Constitution of the United States.

The decision in Executive Benefits, while providing some clarity to practitioners and the public following the Court’s June 2011 decision in Stern v. Marshall, 131 S. Ct. 2594 (2011), nevertheless will make a substantial portion of bankruptcy litigation matters more cumbersome and potentially more expensive to guide through the bankruptcy system.  Clients and practitioners are best advised to hire knowledgeable counsel to help navigate the more complex procedural waters created by this decision. 

Although the Court in Executive Benefits did resolve a pending procedural question that had dogged practitioners since Stern was decided in 2011, the Court’s decision in Executive Benefits now makes it abundantly clear that many disputes that were previously heard and decided in the nation’s bankruptcy courts can no longer be decided there and must be submitted to the district courts for full de novo review and entry of a final judgment or order.  It is difficult to see how this decision will not make bankruptcy litigation more cumbersome and expensive by adding an additional layer of judicial involvement to many matters, notably to fraudulent transfer and other avoidance “claw back” actions that historically have been decided in the bankruptcy courts and used famously in Madoff and other cases as an efficient device for creating value for creditors.  

In Executive Benefits, the Supreme Court reviewed the decision of the United States Court of Appeals for the Ninth Circuit, in which the Ninth Circuit had determined that under Stern and other Supreme Court precedent, the Constitution of the United States does not empower bankruptcy judges to enter final orders and judgments in fraudulent transfer actions, a common form of “claw back” suit.  See Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency, Inc.), 702 F. 3d 553, 556, 565 (9th Cir. 2012).  The Ninth Circuit held that in cases involving private, state-law legal rights in which no proof of claim has been filed by the defendant, bankruptcy judges are only Constitutionally empowered to submit proposed findings of fact and conclusions of law to the United States district courts for review and approval and for entry of final judgments or orders.  Id. at 566.  Despite this Constitutional limitation, the Ninth Circuit went on to rule that the Executive Benefits Insurance Agency, which had been sued by a bankruptcy trustee in a fraudulent transfer “claw back” case, had nevertheless consented to entry of a final judgment by the bankruptcy judge because it had not challenged the bankruptcy judge’s power to enter final judgment soon enough in the process.  Id. at 568-69.  The Executive Benefits Insurance Agency sought Supreme Court review of the Ninth Circuit’s decision.  While the Supreme Court was expected to address the issue of whether parties can consent to a bankruptcy judge entering a final judgment on a fraudulent transfer claim or whether such consent is forbidden by the Constitution, it did not do so and deliberately side-stepping that issue.  Instead, the Court determined that in cases where the bankruptcy court was empowered by a federal bankruptcy statute enacted by Congress to decide a dispute, but was barred from doing so by the Constitution of the United States (so-called “Stern claims”), the bankruptcy court could hear the case but could not enter a final judgment or order and was required to submit proposed findings of fact and conclusions of law to the district court for a complete de novo review and entry of final judgment or order.  Since that is what the district court in fact had done in the Executive Benefits case (without being asked to do so by the parties or the bankruptcy judge), the Court saw no reason to address the consent issue and simply affirmed the Ninth Circuit’s decision.

Executive Benefits did officially upend years of practice by bankruptcy judges in “claw back” litigation by confirming and clarifying that Stern bars bankruptcy judges from deciding such matters, where no proof of claim has been filed by the defendant.

If there was any doubt about the limits placed on bankruptcy courts’ powers by the Court’s 2011 decision in Stern, that doubt has now been removed by the Court’s decision in Executive Benefits.

For additional information regarding this alert, please contact Earl M. Forte (fortee@whiteandwilliams.com / 215.864.6822). Earl has worked extensively in bankruptcy litigation matters for over 25 years.  He is the author of The Fraudulent Transfer Handbook – A Practical Guide for Lawyers and Their Clients (1st Ed. 2013), available on Amazon.com.  A supplement to his book is planned for 2014. 

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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