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July 24, 2014

Seventh Circuit Sides with Sixth Circuit in Stern Bankruptcy Split

Adding to the split of authority that has developed since the Supreme Court’s decision in Stern v. Marshall, 131 S.Ct. 2594 (2011), in Wellness Int’l Network Ltd. v. Sharif, No. 12-1349 (Aug. 21, 2013), the 7th Circuit aligned with the 6th Circuit’s decision in Waldman v.  Stone, 698 F.3d 910 (6th Cir. 2012), to hold that a party may not consent or waive objection to the limited Constitutional authority of an Article I bankruptcy court.  The Wellness Court also held that the bankruptcy courts lack statutory authority to issue proposed findings of fact and conclusions of law in those core matters that cannot be constitutionally “determined” by them.

On both of these points, the Wellness decision conflicts with the 9th Circuit’s decision in In re Bellingham Ins. Agency, Inc., 702 F.3d 553 (9th Cir. 2012), which is currently before the Supreme Court on certiorari to resolve the conflict with the 6th Circuit’s ruling in Waldman. InBellingham, the 9th Circuit held that a defendant had waived its right to have an Article III judge decide a fraudulent transfer claim, finding as “well established” the waivable nature of this Constitutional right.  Rejecting the 9th Circuit’s analysis, but calling it a “thorny question,” the 7th Circuit concluded that “the Sixth Circuit has the better view under current law,” holding that objections to the bankruptcy court’s Constitutional authority are not waivable.

The Wellness decision arose out of years of contentious litigation between Wellness Int’l (the creditor), and Sharif (the debtor). Sharif ultimately filed a Chapter 7 bankruptcy case and claimed in that case that certain assets were not his, but instead were owned by a trust of which he was trustee. Wellness Int’l filed a complaint objecting to Sharif’s discharge, and included in that complaint one count for a declaratory judgment seeking to determine that the alleged trust was in fact Sharif’s alter ego.

After numerous discovery violations, the bankruptcy court entered a default judgment on all five counts of the complaint as a discovery sanction. On appeal, the 7th Circuit held that the bankruptcy court had Constitutional authority to enter final judgment as to the four denial of discharge counts, but not as to the alter ego count. As to the alter ego count, the 7th Circuit held that an objection based on the bankruptcy court’s Constitutional authority was not waivable because it implicates separation-of-powers principles. The Court focused on the perceived dilution of the Article III judicial power that would result from allowing non-Article III judges to enter final orders. Because that objection was not waivable, the 7th Circuit also held it could be raised for the first time on appeal. Moreover, while remanding to the District Court for determination of whether this was a core proceeding, the 7th Circuit held that if it was a core proceeding, then no statutory provision authorizes a bankruptcy court to issue proposed findings of fact and conclusions of law in a core matter.

The practical implication for litigants in the 7th Circuit – at least until the Supreme Court resolves this circuit split – is that all core proceedings as to which bankruptcy judges lack Constitutional authority to issue final judgments must be heard and determined by District Court judges. Examples of such core proceedings as to which bankruptcy judges lack Constitutional authority to issue final judgments include avoidance actions and other state law claims against third parties that have not filed claims against the estate. Thus, the oddity of the Wellness decision was that it was the debtor – who voluntarily availed himself of the bankruptcy court – that raised the Constitutional authority issue in this appeal, and not a third party.

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About the Author

Mark Bloom, Financial Attorney, Greenberg Traurig Law Firm
Co-Chair, National Business Reorganization & Financial Restruct

Mark's diverse experience spanning more than 30 years includes all areas of U.S. and cross-border financial restructuring, reorganization and bankruptcy, involving the representation of debtors, trustees, secured and unsecured creditors and official committees, and purchasers of troubled companies and their assets, both in and out of bankruptcy court. Mark was inducted as a Fellow in the prestigious American College of Bankruptcy in 1998, and currently serves as its Vice President. Mark has been listed in The Best Lawyers in America since 1993, and is also listed in both The Chambers...

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About the Author

Scott Grossman, bankruptcy, attorney, Greenberg Traurig, law firm
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An experienced bankruptcy litigator based in the firm’s Fort Lauderdale and Miami offices, Scott M. Grossman represents debtors, trustees, landlords, secured and unsecured creditors, and asset purchasers in all aspects of bankruptcy matters. Scott has significant experience in bank holding company and hotel bankruptcy cases, and has represented trustees in large, complex bankruptcy cases. Scott also has substantial experience in bankruptcy tax matters and in litigation related to Florida’s constitutional homestead exemption.

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Prof. G. Ray Warner is a professor of law and the director of the Masters in Bankruptcy Program at St. John's University School of Law in New York. Prior to joining the St. John's faculty, Professor Warner was the William B. Boreland Distinguished Scholar and Professor of Law at the University of Missouri-Kansas City School of Law.

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