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Litigation: A “Stern” change in the bankruptcy landscape

Supreme Court case bars federal bankruptcy courts from entering some final judgments.

In Stern v. Marshall, Chief Justice John Roberts penned an opinion with enormously far-reaching consequences for bankruptcy practice, and especially the defense bar. Reading Stern even narrowly, it does what Justice William Brennan for the Northern Pipeline Constr. Co. v. Marathon Pipe Line Co. plurality could not do: Bar federal bankruptcy courts from entering final judgment on at least some “core” proceedings. 

The case arose from a familiar fact pattern. When her husband J. Howard Marshall passed away, the model, star and cultural icon Anna Nicole Smith (also known as Vickie Lynn Marshall) filed for bankruptcy. Her stepson, E. Pierce Marshall, filed a proof of claim alleging defamation, and under state law she counterclaimed, claiming that Pierce had fraudulently prevented his father from including her in his will. Anna Nicole won her counterclaim, and a California bankruptcy court followed with a judgment that purported to enrich the estate by almost $500 million. In post-judgment proceedings, Pierce took the novel position that the bankruptcy court lacked jurisdiction over Anna Nicole’s counterclaim. On the case’s second visit to the Supreme Court, the justices confronted the question squarely.

For the majority, Chief Justice Roberts acknowledged that, according to the Bankruptcy Act, a counterclaim filed in answer to a proof of claim is a “core” proceeding, which Congress permitted bankruptcy courts to resolve without first submitting recommended findings to the district court. But this delegation effected an unconstitutional attempt to assign away some significant portion of their Article III jurisdiction: common law rights. These rights, like those contemplated by Anna Nicole Smith’s counterclaim, did not fall into the narrow category of issues that may be assigned to Article I courts consistent with Marathon Pipeline. Common law probate remedies are not, for example, “public” rights, or rights created entirely by statute. Because adjudicating such claims lies at the heart of the Article III judicial power, Congress could not place this function within the bankruptcy courts, and Anna Nicole’s judgment was invalid.

Reading Stern for only what it says, and nothing more, as some courts have done, bankruptcy courts have lost nothing more than the power “to enter final judgments on counterclaims that are not necessarily resolved in the process of ruling on a creditor’s proof of claim.” But Chief Justice Roberts’ opinion hints to a broader result. At least theoretically, any bankruptcy claim or counterclaim that looks more like a common law claim than a creature of Congress’ exclusive creation may be covered by the logic in Stern. For example, Chief Justice Roberts hints that, drawing on the Court’s prior holding in Granfinanciera, S.A. v. Nordberg, fraudulent conveyance claims under 11 U.S.C. §§ 548-551 are “quintessentially suits at common law” that “resemble state law contract claims,” and, if they will not be resolved in the claims allowance process, they cannot be brought to judgment by a bankruptcy court. At least two bankruptcy courts—one in the District of Montana and one in the Western District of Michigan—have held just that.

Even at this early stage in the post-Stern world, counsel representing defendants in adversary proceedings should assess whether Stern provides a basis for a motion to withdraw the reference, especially if the defendant has not filed a proof of claim against the debtor’s estate. If the claims asserted in the adversary proceeding are governed by state law, such as a “plain vanilla” breach of contract claim (even if it is dressed-up as a turnover claim under 11 U.S.C. § 542), a persuasive argument may be made that the entire adversary proceeding should be adjudicated by an Article III judge in the first instance since this will preserve both judicial and party resources.

As the courts grapple with Stern’s full implications, both the breadth of this decision—and its eventual effect on the adversary proceeding process—remain to be seen.

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Matthew Ingber

Matthew Ingber is a litigation partner at Mayer Brown.

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