Bankruptcy Courts Largely Silent On Whether They Can Police Their Own Limited Authority Under Stern V. Marshall

Almost a year has passed since the Supreme Court issued its landmark decision in Stern v. Marshall.[1]  And courts and commentators are all over the map about the limits that Stern placed on the bankruptcy courts’ authority.  Despite extensive published discourse regarding Stern’s constitutional importance, however, almost no one seems to have addressed a more basic question: who is responsible for policing the constitutional limits of bankruptcy court authority?

The Stern Court struck down as unconstitutional a statute long relied upon by bankruptcy courts to decide a variety of common law claims simply because those claims were somehow connected with a bankruptcy proceeding.  Stern held that, despite a long-standing practice of resolving common law disputes, non-Article III bankruptcy courts cannot “exercise[] the judicial Power of the United States in purporting to resolve and enter final judgment on a state common law claim” under 28 U.S.C. § 157(b)(2)(C).[2]  And while a significant number of post-Stern opinions have applied this limit on the bankruptcy courts’ authority, the cases almost invariably fail to explain who is responsible for enforcing this important constitutional limit.  Indeed, it is unclear whether a bankruptcy judge can decide his or her own constitutional authority or whether the federal district courts must make that determination.

Stern affirmed that the protections afforded by Article III are fundamental, not merely to ensure the separation of power amongst the three branches of government, but to protect the right of individuals to have their claims adjudicated by an independent judiciary.  Indeed, the Stern Court said that Congress had improperly chipped away at these essential safeguards by delegating judicial authority to non-Article III bankruptcy courts.  Yet in the wake of Stern’s constitutional pronouncement, bankruptcy courts themselves are often left to police the limits of their own authority.     Since bankruptcy courts are courts with limited powers, they should not be left to determine their own constitutional authority.  That decision should lie with the Article III district courts.

1.The Stern v. Marshall Decision.

Although the 1984 Bankruptcy Amendments and Federal Judgeship Act created a statutory framework for referring bankruptcy cases and proceedings to bankruptcy courts, Stern declared that scheme at least partially unconstitutional.  In Stern, the Supreme Court analyzed a bankruptcy court’s resolution of a counterclaim the debtor asserted against a creditor who submitted a proof of claim.  The debtor’s counterclaim was based in state common law and was a “core proceeding” under the Bankruptcy Code.  Thus, the Stern Court concluded that, “although the Bankruptcy Court had the statutory authority [under 28 U.S.C. § 157(b)] to enter judgment on [the] counterclaim, it lacked the constitutional authority to do so.”[3]

According to Stern, the U.S. Constitution’s system of separation of powers did not allow the Bankruptcy Code to remove from Article III judges and give to any non-Article III judge authorization to decide “any matter which, from its nature, is the subject of a suit at the common law, or in equity, or admiralty.”[4]  “When a suit is made of ‘the stuff of the traditional actions at common law tried by the courts at Westminster in 1789,’ and is brought within the bounds of federal jurisdiction, the responsibility for deciding that suit rests with Article III judges in Article III Courts.”[5]

Bankruptcy judges are neither Article III courts nor are they adjuncts of Article III courts.  Bankruptcy judges do not enjoy the Article III protections of lifetime appointments and salaries that may not be diminished by Congress.[6]  Because bankruptcy judges do not offer those assurances of an independent judiciary, they do not offer the same protections for both the Judicial Branch and the individual parties and cannot hear all of the same claims an Article III court may hear.[7]  Also, because bankruptcy courts are authorized to hear “all matters of fact and law in whatever domains of the law” and can enter final judgments when adjudicating core proceedings, they are not merely acting as adjuncts to the district courts.[8]  Because bankruptcy courts are not Article III courts and are not adjuncts to Article III courts, they cannot hear claims that must be adjudicated by Article III courts.

The Supreme Court historically has recognized some exceptions to Article III (including territorial courts, courts martial, and the “public rights” exception),[9] but adjudicating a debtor’s common-law counterclaims against a creditor is not one of them.[10]  Although Stern affirmed that the “public rights” exception includes “cases in which the claim at issue derives from a federal regulatory scheme” such as the Bankruptcy Code,[11] a claim “at common law that simply attempts to augment the bankruptcy estate . . . must be decided by an Article III court” and does not fall within that exception.[12]

Consequently, the Stern Court held that a bankruptcy judge is not constitutionally authorized to hear as part of the bankruptcy case a counterclaim that “is a state law action independent of the federal bankruptcy law and not necessarily resolvable by a ruling on the creditor’s proof of claim in bankruptcy.”[13]

2.Constitutionally, Only an Article III Court Should Decide the Question Regarding the  Bankruptcy Court’s Constitutional Authority.

Bankruptcy courts should not sit in judgment of their own authority to hear common-law counterclaims independent of the federal bankruptcy scheme.  Stern held that bankruptcy judges, who lack the lifetime tenure and salary protections afforded by Article III, cannot exercise “prototypical” judicial power.[14]  And the exercise of judicial power – by definition – includes the resolution of whether Article III limits the bankruptcy court’s authority.

When faced with a motion to withdraw the reference, some district courts have incorrectly suggested that a bankruptcy court should first address the question regarding constitutional authority and make a recommendation to the district court.  But even if it were proper to divorce the requested relief (i.e., withdrawing the reference) from the legal basis for that relief (i.e., the bankruptcy court’s lack of constitutional authority), it would not be constitutionally proper to permit the bankruptcy court to police its own constitutional authority.  How can the bankruptcy court pass judgment on the scope of its own authority to hear a claim if the Supreme Court has held that the bankruptcy court lacks the constitutional power to finally adjudicate the underlying claims?

Permitting the non-Article III bankruptcy court to police its own jurisdiction would improperly “chip away at the authority of the Judicial Branch,” which Stern explicitly declared offensive to the Constitution.[15]  Indeed, even the Dissent in Stern recognized that “a delegation of authority to a non-Article III judge to adjudicate a claim of that kind poses a heightened risk of encroachment on the Federal Judiciary.”[16]  If delegating authority to a non-Article III judge to adjudicate a common-law counterclaim is an untenable risk, asking a non-Article III judge to regulate its own authority to adjudicate that counterclaim runs even further afoul of the guidance set forth in Stern.

3. Based on Applicable Rules, the District Court Should Decide a Motion to Withdraw the Reference in the First Insance.

The foregoing constitutional analysis is supported by the Federal Rule of Bankruptcy Procedure, which require an Article III court to address the scope of a bankruptcy court’s authority.  Regardless of the legal grounds, a motion to withdraw the reference from a bankruptcy court must be made to the district court.[17]  “Rule 5011 governs motions for withdrawal of reference, requiring that such motions be determined by the district court.”[18]  A bankruptcy judge may not conduct the hearing on a withdrawal motion because that decision “is committed exclusively to the district court.”[19]

Numerous courts have denied “request[s] that [the bankruptcy] court recommend withdrawal of the reference” because “a motion for withdrawal of the reference is properly brought before a district court judge pursuant to Federal Rule of Bankruptcy Procedure 5011(a).”[20]  Reference and withdrawal of a reference is a “one-way street.”[21]  Thus, under applicable rules, a district court should decide a motion to withdraw the reference to a bankruptcy court.

If a district court were to refer a question regarding the import of Stern to the bankruptcy court, the issue would be virtually certain to re-surface in the district court later.  Regardless of how the bankruptcy court perceives the limits of its own constitutional authority, one party or the other will inevitably to argue that the bankruptcy court got it wrong or should not have decided the question in the first place or both.  Thus, the district court will eventually have to resolve the question.  Because a district court will be faced with the question anyway, it is not only more constitutionally sound, but is also more efficient, to allow the Article III district judge to make a final determination in the first instance, rather than assigning the question to a subservient court that lacks the power to act.

Because Stern held that a non-Article III bankruptcy court lacks authority to resolve common-law claims and because Rule 5011 explicitly mandates that a district court rule whether withdrawing the reference is appropriate, a district court should make the decision regarding the scope of a bankruptcy court’s constitutional jurisdiction under Stern in the first instance.

[1] 131 S. Ct. 2594 (2011).

[2] Id. at 2611.

[3] Id. at 2601.

[4] Id. at 2609 (internal quotation mark omitted) (quoting Murray’s Lessee v. Hoboken Land & Improvement Co., 59 U.S. 272 (1856)).

[5] Id. (citations omitted) (quoting Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50, 90 (1982) (Rehnquist, J., concurring in judgment)).

[6] 28 U.S.C. § 152(a)(1); see also Northern Pipeline, 458 U.S. at 61.

[7] Stern, 131 S. Ct. at 2609.

[8] Id. at 2618-19; see also Northern Pipeline, 458 U.S. at 85-86.

[9] Northern Pipeline, 458 U.S. at 64-67; Stern, 131 S. Ct. at 2613.

[10] See Stern, 131 S. Ct. at 2611 (disapproving that the bankruptcy court had “exercised the ‘judicial Power of the United States’ in purporting to resolve and enter final judgment on a state common law claim”).

[11] Id. at 2598.

[12] Id. at 2616.

[13] Id.

[14] Id. at 2615.

[15] Id. at 2620.

[16] Id. at 2626 (Breyer, J., dissenting).

[17] See Fed. R. Bankr. P. 5011(a) (“A motion for withdrawal of a case or proceeding shall be heard by a district judge.”).

[18] 9 Collier on Bankruptcy ¶ 5011.01[1].

[19] 1987 Advisory Committee Note to Rule 5011.

[20] In re Horton, 149 B.R. 49, 61 (Bankr. S.D.N.Y. 1992); see also, e.g., In the Matter of Hawkeye Chem. Co., 73 B.R. 318, 320 (Bankr. S.D. Iowa 1987) (“[T]his court concludes it does not have jurisdiction to render a proposed decision concerning mandatory withdrawal of the reference.  A motion for withdrawal of the reference must be brought in the district court.”); In re Bedford Computer Litig., 61 B.R. 594, 595 (Bankr. D.N.H. 1986) (“I rule that [the request for withdrawal of reference] is not properly before this court but rather would only be properly directed to the U.S. district court judge.”).

[21] In re Biglari Import & Export, Inc., 142 B.R. 777, 780 (Bankr. W.D. Tex. 1992) (“The bankruptcy court declines the movant’s invitation to ‘refer or transfer’ this matter to the district court, as there is no rule or statute which permits such a referral or transfer.”).

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