Circuit Split Alert! Sixth and Ninth Circuits Differ on Whether Consent Among Parties Cures Bankruptcy
Business Restructuring, Creditors’ Rights & Bankruptcy Update
Date: February 04, 2013
A circuit split has emerged as a result of recent decisions from the Sixth and Ninth Circuit Courts of Appeals regarding whether a bankruptcy judge may, with the consent of the parties, enter a final order on a matter that would normally require final adjudication by an Article III judge. The split comes less than two years after the U.S. Supreme Court's landmark decision in Stern v. Marshall, in which it narrowed the authority of bankruptcy judges.1 The recent circuit split has heightened the uncertainty regarding the extent of constitutional power held by bankruptcy judges, making it likely that, sooner rather than later, the Supreme Court will again take up and clarify the constitutional role of bankruptcy courts.
The Constitutional Conundrum
Article III of the Constitution vests the judicial authority of the United States in "one Supreme Court, and in such inferior Courts as Congress may from time to time ordain and establish."2 That section also provides judges on such courts with salary that shall not be diminished and tenure for life, and it vests the judicial power of the United States in these judges. United States district judges, circuit judges and justices of the Supreme Court, commonly referred to as "Article III judges," are appointed and confirmed pursuant to this section of the Constitution.
Congress created the bankruptcy courts pursuant to its power under Article I of the Constitution, and bankruptcy judges do not enjoy the same salary and tenure protections afforded to Article III judges. In Stern v. Marshall, the Supreme Court determined, among other things, that the distinction under the Constitution between Article III courts and Article I courts creates a separation of powers issue, one that can only be addressed by limiting the matters on which bankruptcy judges may enter final orders.3
The Supreme Court: Stern v. Marshall
In Stern v. Marshall, the Supreme Court examined whether a bankruptcy judge could enter a final order on a state law counterclaim involving issues not necessary for the bankruptcy court to address as part of the claims allowance process. Chief Justice Roberts, writing for the majority, examined the history of Supreme Court jurisprudence regarding the authority of bankruptcy judges. Upon such examination, the majority determined that with the exception of certain "public rights,"4 Congress cannot withdraw from adjudication by Article III judges any matter that would traditionally constitute a suit at common law.
The majority viewed the issue as one of separation of powers (as opposed to subject matter jurisdiction). It determined that the state law counterclaim was a "core" bankruptcy proceeding within the meaning of the relevant statute (28 U.S.C. ? 157(b)(2)(C)).5 As a result, although the federal statute permitted the bankruptcy judge to adjudicate the counterclaim, Article III of the Constitution did not.6
In its decision, the court left open the question of whether a party may consent to a bankruptcy judge entering a final order on a matter that, absent such consent, would require final disposition by an Article III judge. The Sixth and Ninth Circuit Courts of Appeals, however, have weighed in.
The Sixth Circuit: Waldman v. Stone
In Waldman v. Stone, the Sixth Circuit confronted the question of whether parties to a lawsuit may consent to entry by the bankruptcy court of a final order on a matter that does not fall within the public rights exception.7 There, the plaintiff/debtor brought two types of actions against the defendant. First, the plaintiff asked the bankruptcy court to disallow the defendant's claims against the debtor's bankruptcy estate (Disallowance Claims); second, the debtor sought affirmative damages based on the defendant's fraudulent conduct (Affirmative Claims). Significantly, the defendant expressly stated in his pleadings that both of the debtor's causes of action were "core" proceedings, thereby affirmatively consenting to entry by the bankruptcy judge of final orders on both the Disallowance Claims and the Affirmative Claims.
The bankruptcy court found in favor of the plaintiff, disallowing the defendant's bankruptcy claims, awarding the plaintiff both compensatory and punitive damages, and entering a final order to that effect. The defendant appealed to the district court, which affirmed the bankruptcy court in all respects. The defendant then appealed to the Sixth Circuit.
In its opinion, the Sixth Circuit readily determined that the bankruptcy court had the authority to issue a final order with respect to the Disallowance Claims, as such claims are "part and parcel of the claims-allowance process."8 The court determined, however, that the bankruptcy court could not enter a final order with respect to the Affirmative Claims in which the debtor sought affirmative monetary damages. The Sixth Circuit likened the Affirmative Claims to the counterclaim in Stern, as "claims [that] arose exclusively under state law and [that] existed without regard to any bankruptcy proceeding."9
That finding did not resolve the issue entirely because, unlike in Stern, the defendant in Waldman had expressly consented to entry of a final order by the bankruptcy court on all of the plaintiff/debtor's claims. Thus, the question became whether the defendant could effectively waive the requirement that only an Article III judge may, consistent with the Constitution, enter a final order with respect to the Affirmative Claims. The Sixth Circuit found the defendant's waiver to be ineffective because it "implicates not only [the defendant's] personal right, but also the structural principle advanced by Article III. And that principle is not [the defendant's] to waive."10 Thus, according to the Sixth Circuit, the bankruptcy court could not enter a final order on the debtor's affirmative claims, notwithstanding the defendant's consent. Not long thereafter, the Ninth Circuit also visited the issue.
The Ninth Circuit: In re Bellingham Insurance
A few months after the Sixth Circuit's Waldman decision, the Ninth Circuit departed from Waldman, holding that a party may consent to a bankruptcy judge entering a final order on a matter that, absent such consent, would require final adjudication by an Article III judge.11 In support, the Ninth Circuit noted that the waiver of "the allocation of adjudicative authority between bankruptcy courts and Article III courts is well established."12
The court also reviewed the Supreme Court's decision in Stern and pointed out that the Stern majority's concern with respect to Article III was to "protect primarily personal, rather than structural, interests."13 Finally, citing concerns of defendants "sandbagging" the courts, the panel explained that a party should not be permitted to remain silent about its objection throughout the course of litigation, only to belatedly raise the concern if it loses. Based on these considerations, the Ninth Circuit held that a party may consent to a core matter being decided by a non-Article III bankruptcy judge.
Courts Outside the Sixth and Ninth Circuits
Although the Sixth and Ninth Circuit Courts of Appeals are the only circuit courts of appeals to have addressed the issue, two recent lower court decisions within the Second and Eighth Circuits are worthy of note. Bankruptcy Judge Martin Glenn in the Southern District of New York, construing Second Circuit precedent (decided well prior to Stern v. Marshall) and considering the waiver issue, recently stated that Waldman is inconsistent with controlling Second Circuit doctrine and that Bellingham reflects existing Second Circuit law.14 Per Judge Glenn, a party in the Second Circuit may impliedly consent to a final adjudication by a bankruptcy judge on a matter that would otherwise implicate constitutional concerns.
In like fashion, the Bankruptcy Appellate Panel for the Eighth Circuit Court of Appeals, relying in part on Bellingham, arrived at the same conclusion. There, the panel held that a defendant may effectively consent to a final judgment from the bankruptcy court on a matter for which the court would otherwise lack constitutional authority to enter such a judgment.15
For practitioners and parties in bankruptcy litigation, the split between the Sixth and the Ninth Circuits is likely to increase uncertainty and lead to the "jurisdictional ping-pong" warned of by the dissenting justices in Stern.16 If the Sixth Circuit's view is widely adopted, the concern with bankruptcy judges entering final orders on a range of issues will become functionally equivalent to a subject matter jurisdiction issue - one that is unwaivable and that could be raised at any time during the pendency of a case. Thus, parties will be free to consent to the bankruptcy court hearing a matter and rendering a final judgment, but if the party is dissatisfied with the decision, it may seek to have it set aside or converted to proposed findings of fact and conclusions of law on the basis that the bankruptcy court lacked constitutional authority to enter the decision. Such a scenario will lead to a delay in final decisions, increased costs and bankruptcy litigation increasingly shifting away from the bankruptcy courts to the district courts.
Until the Supreme Court resolves the waiver issue or Congress addresses it through appropriate legislation (such as by establishing bankruptcy courts as Article III courts), uncertainty within the bankruptcy system will be acute, and with that uncertainty will come practical consequences. For example, in the Sixth Circuit and any other circuit that may adopt a similar view on waiver - or, for that matter, any circuit that has yet to address the waiver issue - commercial debtors who have a choice concerning where to file for bankruptcy may seek bankruptcy protection elsewhere.
The Supreme Court's decision in Stern left many unanswered questions; however, until the Sixth Circuit issued the Waldman decision, few doubted that a bankruptcy judge could, with the consent of the parties, enter a final order on matters that would otherwise have to be heard by an Article III judge. With the conflicting views on the issue emerging among the circuits, the uncertainty introduced into the bankruptcy world since Stern has intensified.
The ongoing ambiguity concerning the effect of separation of powers doctrine in the bankruptcy system will likely lead to the Supreme Court again taking up the issue of the extent of bankruptcy court constitutional authority, an issue that has troubled the bankruptcy system since the passage of the Bankruptcy Code in 1978. Very notably, the implications are not necessarily limited to the bankruptcy system. Indeed, the same rationale applied by the Waldman court to determine that parties may not consent to certain adjudications by Article I bankruptcy judges could also apply to other non-Article III judges, including federal magistrate judges.
3It is worth noting this is not the first time the Supreme Court has found constitutional flaws in the federal statutory mechanisms by which bankruptcy judges are appointed. See, e.g., Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982).
4Under "public rights" doctrine, non-Article III courts may resolve matters that historically could have been determined exclusively by executive or legislative branches of government. Public rights include claims deriving from a federal regulatory scheme, or claims that by their nature must be resolved by a federal agency and are directly related to the agency's function. "Private rights," on the other hand, are unrelated to the bankruptcy claims allowance process (other than that they may serve to augment the bankruptcy estate), and they include state law contract disputes. Simply put, public rights involve claims between the government and another party; private rights involve claims between private parties.
5In general terms, "core" proceedings are matters that involve substantive bankruptcy rights or that only arise in the bankruptcy context. "Non-core" proceedings, on the other hand, are actions that do not arise due to the filing of a bankruptcy, but that may affect or be affected by the bankruptcy.
14See Executive Sounding Board Associates, Inc. v. Advanced Machine & Engineering Co. (In re Oldco M Corporation f/k/a Metaldyne Corporation), No. 11-1939, 2012 Bankr. LEXIS 5869 (Bankr. S.D.N.Y. Dec. 20, 2012) (construing Second Circuit precedent in Men's Sportswear, Inc. v. Sasson Jeans, Inc. (In re Men's Sportswear, Inc.), 834 F. 2d 1134 (2d Cir. 1987)).