Becoming the first Court of Appeals to address an issue that has divided the bankruptcy and district courts, the Ninth Circuit adopted a forceful view of Stern v. Marshall,1 to hold in In re Bellingham Insurance Agency, Inc. 2 that absent the parties’ consent, the limitations imposed by Article III of the Constitution deprive a bankruptcy judge of the constitutional authority to enter judgment on fraudulent transfer claims brought against parties who have not filed proofs of claim. Agreeing with the majority of lower courts to address the issue, the Ninth Circuit went on to conclude that, notwithstanding the absence of express statutory authority to do so, a bankruptcy judge may issue proposed findings and conclusions on such claims in lieu of entering judgment. Finally, the Ninth Circuit held that the right to adjudication before an Article III judge can be waived, creating a split of authority on this issue with the Sixth Circuit’s recent decision in Waldman v. Stone. 3
The factual and procedural underpinnings of Bellingham Insurance Agency are typical of the daily work of bankruptcy courts across the country. A chapter 7 trustee brought suit against an entity controlled by the debtor’s former officer asserting (among others) federal and state law claims for fraudulent transfer to recover the debtor’s property and a “mere successor” claim to hold the successor entity liable for the debts of the debtor. The defendant entity, which had not filed a proof of claim, demanded a jury trial and the district court treated that demand as a motion to withdraw the reference from the bankruptcy court. Rather than pursue its withdrawal motion, the defendant requested that the district court delay action pending the bankruptcy court’s ruling on the trustee’s motion for summary judgment. After the bankruptcy court entered summary judgment in favor of the trustee, the defendant abandoned its withdrawal motion and instead appealed to the district court. At no time before the bankruptcy or district courts did the defendant raise an objection to the bankruptcy judge’s constitutional authority. On appeal to the Ninth Circuit, the court held that the defendant waived its right to adjudication by an Article III judge and affirmed the bankruptcy court’s entry of summary judgment.
Turning first to whether bankruptcy judges have constitutional authority under Article III to enter judgment on fraudulent transfer claims against defendants who have not filed claims, the Ninth Circuit concluded that Granfinanciera, S.A. v. Nordberg 4 and Stern “settle” the issue. 5 A bankruptcy judge lacks constitutional authority to determine such claims. A fraudulent transfer action involves a “private right” regardless of whether it arises under state or federal law or even underfederal bankruptcy law. The action, however, may be assigned to a non-Article III court if it becomes part of the claim-allowance process. This could happen if thedefendant files a proof of claim and if the bankruptcy court’s adjudication of the claim necessarily resolves the issues that are raised by the fraudulent transfer action. Since the defendant in this case did not file a proof of claim, the bankruptcy judge lacked constitutional authority over the fraudulent transfer action brought against it.
The immediate implication of Bellingham Insurance Agency is to seriously undermine those decisions of bankruptcy and district courts outside the Ninth Circuit holding that a bankruptcy judge has constitutional authority over a fraudulent transfer claim simply because it arises under section 548 (or in some cases section 544) of the Bankruptcy Code. As the Ninth Circuit has forcefully shown, that view is simply not tenable when Granfinanciera and Stern are correctly read and interpreted together. A bankruptcy judge’s constitutional authority turns not on the source of the claim—e.g., whether it arises under section 548 of the Bankruptcy Code—but on the claim’s connection to the claims-allowance process—i.e., whether the claim is necessarily resolved through adjudication of a proof of claim. This implication surely extends to section 547 preferences 6 and perhaps to all suits that can be said to be “quintessentially suits at common law.” 7
The Ninth Circuit acknowledged that its holding creates a “gap” in the statutory framework allocating adjudicative authority between the bankruptcy and district courts. Although the framework expressly authorizes bankruptcy judges to “hear and determine” fraudulent transfer claims, it does not expressly authorize bankruptcy judges to “submit proposed findings of fact and conclusions of law to the district court” on such “core matters.” 8 This gap arguably prevents a bankruptcy court from handling such unconstitutionally-core claims and would require that all such actions be withdrawn to the district court. Relying on the legislative purpose to “expand the bankruptcy court’s jurisdiction to its constitutional limit,” 9 the Ninth Circuit reasoned that the “power to ‘hear and determine’” fraudulent transfer claims “surely encompasses the power to hear” such claims and submit proposed findings and conclusions. 10
The effect of the narrowed scope of bankruptcy judges’ constitutional authority remains to be seen. Certainly, in ruling that the statutory gap does not preclude the bankruptcy court from issuing proposed findings and conclusions subject to de novo review by the district court, the Ninth Circuit viewed the existing bankruptcy system as having been left largely intact. There may, however, be cause for concern that this ad hoc system will not run as efficiently as under the statutory framework as written. The Ninth Circuit dismissed the Seventh Circuit’s decision in In re Ortiz, 11 but did not acknowledge that the two courts addressed two possibly different issues: on the one hand, whether a bankruptcy judge has authority to issue a report and recommendation, and on the other, whether appellate jurisdiction exists when the bankruptcy court erroneously enters judgment rather than issues a report and recommendation. Furthermore, because Bellingham Insurance Agency was decided on summary judgment, there was no cause to consider the proper procedure to be used when after trial a bankruptcy court proceeds erroneously to enter judgment rather than proposed findings and conclusions. Nor was there cause to consider whether orders denying motions for summary judgment (or other dispositive motions) should be submitted to the district court for immediate consideration.
While this opinion arguably creates a circuit court split on the statutory gap issue, it clearly creates a split on the question of waiver. On the waiver point, the Ninth Circuit held that the bankruptcy judge in this case had authority to enter judgment because the defendant waived its right to adjudication before an Article III judge. The Article III right is waiveable, the Ninth Circuit reasoned, because it was waiveable under the bankruptcy laws before the Bankruptcy Act of 1978 and the right itself “‘serves to protect primarily personal, rather than structural, interests.’” 12 Further, the court held that the waiver need not be express, but may be implied.Without setting forth a general standard for determining when the Article III right is waived, the court concluded that the defendant in this case impliedly consented to entry of judgment by the bankruptcy court because it asked the district court to delay a ruling on withdrawal and failed to object to the bankruptcy judge’s constitutional authority until the eve of oral argument before the Ninth Circuit.
The ruling that the Article III right may be waived may also limit the effect of the Ninth Circuit’s ruling in this case on the day-to-day management of the bankruptcy system. But questions concerning the scope of this waiver rule remain unanswered. The Ninth Circuit emphasized that its finding of implied consent did not arise because the defendant “simply fail[ed] to object.” 13 Certainly a defendant would be wise to raise an objection to the bankruptcy judge’s adjudicative authority at the earliest stage. But, it is not clear that a local rule aiming to deem consent when an objection is not raised early in a case—e.g., before demand for a jury trial would be due 14 or before 14 days after entry of an order 15—would survive under Bellingham Insurance Agency.
The position of the Ninth Circuit that the Article III right is a personal right subject to waiver by a litigant is in direct conflict with the position of the Sixth Circuit in Waldman – that the Article III right is a structural protection not waiveable by litigants. One can only speculate whether this split means an early return to the Supreme Court. But the split may well engender further litigation in other circuits. Whatever the outcome of the personal right vs. structural protection debate, it is clear in the Ninth Circuit that the bankruptcy court’s constitutional authority does not extend to fraudulent transfer claims against parties who have not filed proofs of claim. In light of the forcefulness of the court’s decision, this rule may well be adopted by other courts of appeals that certainly will be called upon to address the issue in the future.
1 ___ U.S. ___; 131 S.Ct. 2594 (2011).
2 ___ F.3d ___, No. 11-35162 (9th Cir. Dec. 4 2012).
3 ___ F.3d ___, 2012 WL 5275241 (6th Cir. Oct. 26, 2012).
4 492 U.S. 33 (1989).
5 Bellingham Ins. Agency, No. 11-35162, slip op. at 23 (citing 28 U.S.C. § 157(b)(1) & (c)(1)).
6 See id. at 21 (“Granfinanciera noted that actions to recover preferences are ‘indistinguishable . . . in all relevant respects’ from actions to recover fraudulent conveyances”) (citing Granfinanciera, 492 U.S. at 48-49).
7 See id. at 39.
8 Id. at 24.
9 Id. at 25.
11 665 F.3d 906 (7th Cir. 2011).
12 Id. at 28 (quoting Commodity Futures Trading Comm’n v. Schor, 478 U.S. 833, 848 (1986)).
13 Id. at 30.
14 Id. at 21 (“Stern fully equated bankruptcy litigants’ Seventh Amendment right to a jury trial in federal bankruptcy proceedings with their right to proceed before an Article III judge.”).
15 The time to object to a magistrate judge’s report and recommendation on a dispositive motion. See Fed.R.Civ.P. 72(b).©2013 Greenberg Traurig, LLP. All rights reserved.