Thursday, July 9, 2015

Wellness International v. Sharif: The Supreme Court Decides Whether Consent Permits Entry of Final Orders on Non-Core Issues and “Stern” Claims

By Louis S. Robin
Law Offices of Louis Robin
Longmeadow, MA  

 The Supreme Court, in an opinion eagerly anticipated by bankruptcy practitioners and the bankruptcy judiciary, has issued its opinion in Wellness International v. Sharif.   The Court permitted parties to consent to entry of final orders in non-core and “Stern” issues. As a 6 – 3 decision, there are still issues remaining to be decided.

Factual Background

            Richard Sharif was the debtor/defendant in a dischargeability case which included a count seeking to determine that a trust, which the debtor alleged he administered for the benefit of his mother and sister was Sharif's alter ego and that its assets were part of the bankruptcy estate. Although litigation persisted with the alleged consent of the debtor Sharif, default judgments were eventually issued by the Bankruptcy Court, including Count V regarding the trust. This trust judgment was reversed by the Seventh Circuit which ruled that the Bankruptcy Court did not have jurisdiction, regardless of consent, to issue judgments on these claims which could be considered “Stern” claims – that is, final judgments on “claims that seek only to 'augment' the bankruptcy estate” and would otherwise “exis[t] without regard to any bankruptcy proceeding.” Slip Opinion at 9, citing Stern, 564 U.S. at ___, ___ (slip Op., at 27, 34). The debtor Sharif's sole defense on appeal was that the Bankruptcy Court lacked jurisdiction to issue final judgments, regardless of consent. 

Justice Sotomayor's Opinion for the Majority

            Justice Sotomayor wrote for a 6 – 3 majority. This decision traced the history of consent, noting that reference of disputes to non-Article III referees, arbitrators, and masters for entry of final decisions took place in the “early days of the Republic”and cited a 1813 Supreme Court case which affirmed damages in two actions that “were referred, by consent under a rule of Court to arbitration.” Thornton v. Carson, 7 Cranch 596, 597 (1813). Justice Sotomayor then thoroughly discussed the more recent Commodity Futures Trading Comm'n v. Schor, 478 U.S. 833 (1986) regarding an Article I tribunal litigation of state law claims, and then turned to Gomez v. United States, 490 U.S. 858 (1989) and Peretz v. United States, 501 U.S. 923 (1991) concerning Magistrates' authority for conducting trials resulting in final determinations. Justice Sotomayor stated that an “expansive reading of Stern, moreover, would be inconsistent with the opinion's own description . . . that the question before it was a 'narrow' one, and that its answer did 'not change all that much'”. Slip Opinion at page 16.  My brief review of Justice Sotomayor's analysis does not do justice (no pun intended) to her thorough opinion which supports the conclusion she provided in the introduction of her opinion: “Our precedents make clear that litigants may validly consent to adjudication by bankruptcy courts.” Slip Opinion at page 8.

            The only remaining issue was the standard of consent necessary. Justice Sotomayor rejected that the requisite consent must be “express”. Whether express or implied, it must be “knowing and voluntary.” The 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 adjudicator. She referred this finding of fact to the original trial court for determination.

Justice Alito's Concurrence

            Justice Alito joined the majority in a brief concurring opinion. He enthusiastically endorsed Justice Sotomayor's analysis by saying that her reasoning “would seem to fall within the Court's previous rejection of 'formalistic and unbending rules.'” The focus of his opinion, however, was on consent – he noted that Bankruptcy Rule 7012(b) requires “express” consent for non-core matters, although the Sharif debtor's failure to raise the consent issue earlier was fatal in the Justice's opinion.

Chief Justice Roberts' Dissent

            Chief Justice Roberts dissented – not because he disagreed with the ultimate decision, but because he disagreed with its reasoning and that the majority opinion threatened constitutional separation of powers principles. Although the second part of his decision regarding separation of powers and other constitutional issues is the most significant, an initial discussion regarding his rationale for approving the result touches traditional issues that may interest the traditional bankruptcy practitioner, and I will address that first.

            Chief Justice Roberts agreed with the outcome because he analyzed the issue in terms of “res” – “At its most basic level, bankruptcy is ‘an adjudication of interests claim in a res.’” Chief Justice Roberts, dissenting, Slip Opinion at page 5, citing Katchem v. Landy, 382 U.S. 323, 329 (1966). It is ironic that Justice Roberts cited Katchem v. Landy, as that decision, for many years, was cited often in support of bankruptcy jurisdiction over creditors having previously filed proofs of claims, and even as support for 28 U.S.C. §158(b)(2)(c)’s definition of core proceedings to include “counterclaims by the estate against persons filing claims against the estate”. Indeed, support for broad Bankruptcy Court jurisdiction based upon adjudication of a “res”, was generally, if not specifically, rejected in Stern.

            Chief Justice Roberts, continued on this path, noted that “[i]dentifying property that constitutes the estate has long been a central feature of bankruptcy adjudication.” This charge was present under English bankruptcy law, America’s first bankruptcy statute enacted in 1800, and other provisions. Still, Justice Roberts limited this issue of a “res” as it did not extend to situations where a “third party asserted a ‘substantial adverse” claim [in the res]”. Chief Justice Robert, dissenting, Slip Opinion at page 7, citing Taubel-Scott-Kitzmiller Co. v. Fox, 264 U.S. 426, 433 (1924). Similarly, so that no one could believe that the Court was revisiting Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989), and equating alter ego claims with fraudulent transfer claims, Chief Justice Roberts drew a line by stating that a “fraudulent conveyance claim seeks assets in the hands of a third party, while an alter ego claim targets only the debtor’s ‘second self.’” Chief Justice Roberts, dissenting, Slip Opinion at page 8.

            I question as to how such factual findings of third parties’ substantial adverse claims or a debtor’s second self are to be determined – by the Bankruptcy Court, District Court, or some other party. These lines are difficult to distinguish because fraudulent transfer claims and claims of concealment often overlap. See, e.g., In re Charette, 148 B.R. 94 (Bankr. D. Mass. 1992). They are fact intensive, not subject to simple rules. If Bankruptcy Court authority was expanded to all aspects of the “res”, whether enlarging the res or simply its distribution, the Bankruptcy forum would operate most efficiently, although, admittedly, constitutional issues have prohibited this result.

            Although the preceding leads to the same result as the majority’s position, the second part of Chief Justice Roberts’ dissent concerned the inherent powers of the Article III judiciary. He started this discussion by quoting James Madison in the First Congress: “if there is a principle in our constitution more sacred than another, it is that which separates the Legislative, Executive, and Judicial powers.” “Sacred,”as the Chief Justice notes, is a strong word – and Chief Justice Robert’s analysis does justice (again no pun intended) to such a standard. He discusses the Federalist Papers, Supreme Court decisions and precedents, and the words of the present Justices. And lest anyone believe that the issue of an independent Judiciary is a principle whose importance pales in comparison to others, one only need to look to the Declaration of Independence, which criticized the King as he “made Judges dependent on his Will alone, for the tenure of their offices and amount and payment of their salaries”. Chief Justice Roberts, Slip Opinion at Page 3, quoting the Declaration of Independence, ¶ 11. Chief Justice Roberts argued forcefully for the integrity and power of the Judiciary.

            If I can point to any lapse by Chief Justice Roberts, it is his failure to address James Madison’s words in the Federalist Papers that the “power of establishing uniform laws of bankruptcy is so intimately connected with the regulation of commerce, and will prevent so many frauds . . . that the expediency of it seems not likely to be drawn into question.” (emphasis added). Federalist No. 42, p. 271 (C. Rossiter ed. 1961). Justice Breyer cited these words in his Stern dissent. Stern v. Marshall, Justice Breyer dissenting, Slip Opinion at page 14. Although, in this paragraph’s discussion, I am returning to the first portion of the Chief Justice’s dissent, I believe that this early reference to expediency should not be forgotten. The expediency of bankruptcy is a quality that every bankruptcy practitioner and Bankruptcy Judge recognizes as central to the bankruptcy forum, and certainly lends itself to an expansive view of “res”. Ironically, Chief Justice Roberts choose other words of Justice Breyer as support in his dissent. Slip Opinion at Page 14. Addressing these words of expediency could have been instructive.

Justice Thomas' Dissent

            Justice Thomas provided a scholarly and lengthy discussion on various questions, with the last being the “more difficult question [of] whether consent somehow eliminates the need for an exercise of the judicial power.” He discussed many opinions, commentaries, and sources. Ultimately, he declined to provide answers to these questions as the balance of the Court had decided not to consider them, and, instead joined the first part of the Chief Justice’s dissent concerning the “res” of the bankruptcy estate.


            As a general matter, I believe the issue of consent is resolved for hereafter – six Justices have joined this majority, not the mere five that has been often been the case on close issues dividing the Court. That Justice Alito joined the four other more liberal Justices is certainly unique – I do not keep “statistics” on such issues, but I wonder how often that Justice Alito joins Justices Ginsburg, Breyer, Sotomayor, and Kagan, instead of Justices Roberts, Scalia and Thomas. Perhaps Justice Alito has some experience with the nature of bankruptcy proceedings in prior practice or as an Appeals Judge. In any event, it will be difficult for a future Court to find reason to reverse a 6 – 3 decision that enjoys some diverse support. 

            I also believe that this will result in little change in the practice before the Bankruptcy Court. We should remember that after Northern Pipeline v. Marathon, 458 U.S. 50 (1982) was issued, following some initial disruption, bankruptcy practice proceeded with little disruption. Further, Bankruptcy Rule 7012(b)(2) requires that the “responsive pleading shall admit or deny an allegation that the proceeding is core or non-core. If the response is that the proceeding is non-core, it shall include a statement that the party does or does not consent to entry of final orders or judgment by the bankruptcy judge.” This provides an expedited procedural basis for proceeding. Most often the admission is that the adversary is core or that consent is given; at least I have never seen a Bankruptcy Judge issue proposed findings and rulings for the District Court to review.  The practitioners that toil in the Bankruptcy forum understand the necessity of bankruptcy and its “expediency”, and I am confident that they will make every possible effort to have this system operate efficiently.

            The Bankruptcy Rules should  apply to “Stern” claims as well, in that the party would provide some admission of core or non-core, and any consent. Further, the District Court of Massachusetts has provided for resolution of “Stern” claims under Local Rule 206 for the United District Court for the District of Massachusetts, so that the Bankruptcy Court can issue proposed findings and rulings for the District Court to consider. 

            As far as the concept of “res” expanding to protect the rulings of the Bankruptcy Court in the future, it is doubtful that this concept will be revisited in the future to reverse prior rulings. The Supreme Court is protective of its jurisdiction and the Article III Courts.  Even with Justice Sotomayor’s comment that “it is no exaggeration to say that without the distinguished service of these judicial colleagues [as Bankruptcy Judges], the work of the federal court system would grind nearly to a halt”, the Court will be hesitant to expand the power of the Bankruptcy Court.  But Chief Justice Roberts discussion of the “res”, is perhaps the longest and most supportive of this concept – perhaps it will be utilized to fight off challenges to other aspects of the Bankruptcy Code, such as jurisdictional challenges to exemptions, determinations of the extent, priority, and validity of liens, orders approving sales, confirmation orders, and the variety of other matters concerning the administration of the estate.

            I would suggest that all take the time to read the opinions. My summaries and comments do not do right in characterizing their fullness. They certainly provide us, as daily participants in the bankruptcy world, comfort that we participate in a worthy forum that is rich in democratic principles.

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