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Inside: A Stern decision and what a creditor can take from the ruling

The Supreme Court held in Stern v. Marshall that the bankruptcy court lacked authority to hear the estate matter

A stripper, an 89-year-old billionaire and a drug overdose — whoever said bankruptcy was boring?

By now, the details of the late Anna Nicole Smith’s battle to obtain half of her octogenarian husband’s billion-dollar estate are well known. But less discussed is how her life continues to reshape the practice of bankruptcy law, which may – ironically – be her biggest legacy.

The Stern case

In 1994, Playboy cover girl Smith married her strip club sweetheart, J. Howard Marshall, a billionaire oil tycoon. Smith was 26 and Marshall was 89, a small divide for love. As these things go, Smith became a widow a year later when Marshall died at age 90. Then the fun — which in our world means 15 years of litigation — began.

Briefly, Smith claimed half of her late husband’s fortune, triggering one of his grown children, Pierce Marshall, to immediately fight his stepmother’s claim in Texas probate court. A year later, in 1996, Smith filed personal bankruptcy in California. The dispute proceeded on parallel tracks, meaning the estate fight continued in both Texas state court and in federal bankruptcy court.

Of significance, the legal “hook” for the fight to enter bankruptcy court was because Pierce filed a claim in Smith’s bankruptcy case. Specifically, he filed a claim for defamation against Smith, claiming she had defamed him during the estate fight and the run-up to her bankruptcy. In response, Smith filed a counterclaim against Pierce in bankruptcy court for tortious interference related to what she considered her proper share of the estate. 

The two courts reached conflicting decisions with the Texas court awarding Smith no inheritance, while the bankruptcy court awarded her $450 million. 

The dispute ultimately made it to the Supreme Court — twice, actually. In June 2011, the Supreme Court held in Stern v. Marshall that the bankruptcy court lacked authority to hear the estate matter, notwithstanding that the Bankruptcy Code expressly provides it such authority.

That is, even though Congress passed a statute providing the bankruptcy court to hear such “core” matters, the Supreme Court held that portion of the Bankruptcy Code unconstitutional. Specifically, it held that bankruptcy judges, as non Article III judges, lacked constitutional authority to rule on such matters.

The aftermath

Initially, most commentators considered the ruling limited to the unique facts of the case. In other words, many practitioners reasoned that the holding stood for the narrow proposition that bankruptcy courts only lacked authority to decide counterclaims in state-based matters, as was the case in Stern.

But the Court’s ruling opened a potential Pandora’s Box, the limits of which remain unknown. If the problem was simply interpreting the Bankruptcy Code — a statute — then the fix might be remedied by simply passing a new, improved statute. However, as the Stern court reasoned, the problem was constitutional, meaning there could be no simple statutory fix. 

As a result, in the two years since the decision, lower courts have had to grapple with the reach of the Stern decision. Some pointed questions include:

  • Can parties consent to a bankruptcy court’s jurisdiction?
  • Related, can a party waive a jurisdictional objection, and if so, can the waiver be implied or must it be express?
  • If a bankruptcy court cannot enter final orders in some statutorily defined “core” matters (as was the case in Stern), can it at least enter proposed findings of fact and conclusions of law in such matters?
  • Are there other matters, such as fraudulent conveyance actions and preference actions, for which a bankruptcy court now also lacks jurisdiction?

Basically, the Stern court opened the door to question a bankruptcy court’s jurisdiction on a matter-by-matter basis, potentially throwing the carefully crafted bankruptcy scheme into question. The Court is set to address some of this uncertainty in its existing term through In re Bellingham Ins. Agency, Inc.

What can a creditor or third party do?

Highbrow bankruptcy theory aside, the pointed question becomes what can a creditor or third party do to take advantage of the Stern decision and uncertainty? Here are some points for creditors to consider:

  • Consider not filing a claim. Long before Stern, courts often used the bright line of whether a claim was filed to determine whether a bankruptcy court has jurisdiction to decide a matter. If the goal is to avoid bankruptcy court jurisdiction altogether, then a creditor may want to forego filing a claim. This makes particular sense if the claim is small or there is little chance of recovery in the case. This counterintuitive strategy comes with risks, so it should be carefully weighed in consultation with bankruptcy counsel.
  • Move to withdraw the reference. Post-Stern, one thing remains clear: a district court can always hear any matter that the Bankruptcy Code contemplates. That is, there is no constitutional challenge to an Article III district court hearing a fraudulent conveyance case, regardless of whether the defendant filed a proof of claim. As such, a defendant should consider moving to withdraw the reference to the bankruptcy court, which would result in the matter being heard by the district court. Alternatively, a defendant may seek for the bankruptcy court to abstain from hearing the matter so that a different court — most likely a state court — hears the matter.
  • Take two bites of the apple. Some aggressive parties may strategically choose to litigate a matter before a bankruptcy court, and thereafter — if they lose — argue that the bankruptcy court lacked constitutional authority to hear the matter in the first place. This is essentially what happened in Stern. However, this (expensive) strategy is not without risk as it triggers one of the questions the Supreme Court will soon address: whether parties can consent to a bankruptcy court’s jurisdiction, and if so, how they do so?

Contributing Author

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William Choslovsky

A Harvard Law School graduate who clerked for two courts, William Choslovsky is a partner at Neal, Gerber & Eisenberg LLP (Chicago), where he focuses...

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