A Guest Post by Yitzhak Greenberg: “Deeper into the Darkling Abyss: The 5th Circuit joins the 6th and 7th Circuits in Finding that Consent Cannot Cure A Bankruptcy Court’s Stern Infirmity”

Blogging has enabled me to meet many people I otherwise likely would never have met.  On such person is Yitzhak Greenberg, a bankruptcy attorney in New York City who clerked for Judge Arthur Gonzalez and whose practice is focused on all aspects of bankruptcy (including the representation of both debtors and creditors).  Yitzhak is passionate about contributes to the advancement of our understanding of complex bankruptcy law issues.  Among other things, he has written for The Bankruptcy Strategist and the Norton Bankruptcy Advisor and has participated in panels sponsored by the PLI and Law Journal Newsletters.

He can be reached at [email protected] or [email protected].

Yitzhak has long taken an interest in the bankruptcy jurisprudence expounded by the US Supreme Court.  His discussion in the July 2011 issue of the Norton Bankruptcy Advisor, entitled Credit Bidding After Philadelphia Newspapers: The Fat Lady Has Not Sung, merited citation by the Radlax petitioner in its opening merits brief on the subject of credit bidding.

Yitzhak now graciously offers, through this guest post, an analysis of whether a bankruptcy court can enter a final order in a Stern proceeding with the parties’ consent.  Yitzhak shows that the seemingly obvious answer is anything but.  His discussion is a good preview of the issues that the Supreme Court will address this coming term in Bellingham (see also Weil Bankruptcy Blog for further background into the case).

The famed Professor Karl Llewellyn equated the study and practice of law to the boy in the nursery rhyme who jumps into a bramble bush, thereby scratching out his eyes, and then summons “all his might and main” to jump into a second bush, thereby having them scratched back in.  Yitzhak in this guest post offers “a modest proposal” out of the bramble bush through amendments to the local district courts’ standing orders of reference.  Still, even if Courts were to adopt Yitzhak’s proposal, thereby avoiding further needless brain damage on the issue, the Supreme Court will rule on the issue, thus allowing us to both have the bramble bush and eat it (as suggested by John Heywood in his book of proverbs in 1546).

Special thanks to Yitzhak for offering to share his wisdom with readers of this blog.  My blogging has been a definite casualty of a busier work schedule and pretty mischievous twin boys (now five years older than in this post).  I hope Yitzhak’s second guest post (first one on “Stub Rent”) encourages other guest post submissions (and his return).  With total page views on the blog to date at over 750,000, it’s a good way to hit one’s target audience.

Deeper into the Darkling Abyss: The Fifth Circuit joins the Sixth and Seventh in Finding that Consent Cannot Cure A Bankruptcy Court’s Stern Infirmity

“Or whether instead they [i.e., the Article III Cases] are but landmarks on a judicial ‘darkling plain’ where ignorant armies have clashed by night.” Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 91 (1982), (Rehnquist, J., concurring).

In Stern v. Marshall, 131 S.Ct. 2594, 2609 (2011), the Supreme Court held that Congress’s grant of authority to a bankruptcy court to enter a final judgment in all “core” proceedings violated Article III of the Constitution because Article III prohibits the entry of final judgments by a bankruptcy court (i.e., a non Article III court) in proceedings that are “the stuff of the traditional actions at common law tried by the courts at Westminster in 1789.”  Wellness Intern. Network, Ltd. v. Sharif, 2013 WL 4441926 at *17 (7th Cir. 2013) (quoting Stern, 131 S. Ct. at 2609and Northern Pipeline, 102 S. Ct. 2858, 2881 (1982)). Thus, Stern created a new category of proceedings that are “core” but unconstitutional (hereinafter, “Stern Proceedings”).

The Circuits are split regarding whether consent can cure a bankruptcy court’s infirmity to enter a final order in a Stern Proceeding. The Sixth Circuit concluded that consent cannot cure a bankruptcy court’s Stern infirmity.  Waldman v. Stone (In re Stone), 698 F.3d 910 (6th Cir. 2012). In contrast, the Ninth Circuit found that consent permits a bankruptcy court to enter a final order in a Stern Proceeding.  In re Bellingham Ins. Agency, 702 F.3d 553 (9th Cir. 2012).

The Supreme Court granted certiorari to the appeal of Bellingham. Shortly thereafter, the Seventh Circuit weighed in on the split between the Sixth and Ninth Circuits and agreed with the Sixth Circuit’s decision in Waldman that consent could not cure a bankruptcy court’s Stern infirmity.

More recently, the Fifth Circuit joined the fray and found that the structural concerns of Article III cannot be ameliorated by consent or waiver. In re Frazin, 2013 WL 5495920 (5th Cir. 2013).  In contrast to the Seventh Circuit’s almost eleven-page analyses of consent and the holdings of the other Circuits, the Fifth Circuit addressed consent in a relatively short footnote that failed to discuss WaldmanBellingham, or Wellness.  The Fifth Circuit reasoned:

However, when “separation of powers] is implicated in a given case, the parties cannot by consent cure the constitutional difficulty…. When these Article III limitations are at issue, notions of consent and waiver cannot be dispositive because the limitations serve institutional interests that the parties cannot be expected to protect.” C.F.T.C. v. Schor, 478 U.S. 833, 850–51 (1986). As discussed above, Stern makes clear that the practice of bankruptcy courts entering final judgments in certain state-law counterclaims “compromise[s] the integrity of the system of separated powers and the role of the Judiciary in that system.” 131 S. Ct. at 2620. Thus, structural concerns cannot be ameliorated by Frazin’s consent or waiver.

Frazin, 2013 WL 5495920 at *10, fn. 3 (5th Cir. 2013).

A remarkable feature of the Fifth Circuit’s treatment of consent in Frazin is its failure to distinguish its holding from Technical Automation Services Corp. v. Liberty Surplus Ins. Corp., 673 F.3d 399(5th Cir. 2012). There, the Fifth Circuit determined that Stern does not affect an Article I magistrate judge’s statutory authority to enter final orders on common law causes of action with consent, but avoided making a comparable determination regarding Article I bankruptcy judges, stating: “The similarities between bankruptcy judges and magistrate judges suggest that the Court’s analysis in Stern could be extended to this case, the plain fact is that our precedent in Puryear is there, and the authority upon which it was based has not been overruled”.  Id. at 407.

Frazen, therefore, simply disregards the elephant in the room: If bankruptcy judges and magistrates are similar, why does consent only allow a magistrate judge to enter a final order in matters that would otherwise by the exclusive province of an Article III court?

Before the Seventh Circuit’s decision in Wellness and questions raised by the fact that the US Supreme Court granted certiorari in Bellingham, many courts viewed the Sixth Circuit’s decision in Waldman as aberrational.  Consent was viewed as a cure to a bankruptcy court’s Stern infirmity; parties could simply waive their Article III rights.  Waldman was viewed as inconsistent with the bankruptcy regime’s strong reliance on consent and inapposite to the well-accepted jurisprudence rooted in the bankruptcy case law, the Federal Magistrates Act, and Supreme Court case law.  Case law support is articulated in Bellingham, which concluded that “[i]f consent permits a non-Article III judge to decide finally a non-core proceeding, then it surely permits the same judge to decide a core proceeding in which he would, absent consent, be disentitled to enter final judgment.”  Bellingham, 702 F.3d at 567.  Support in the Federal Magistrate Act is based on the oft-stated similarity between bankruptcy judges and magistrate judges and the fact that the Federal Magistrate Act allows “federal magistrate judges, acting with the consent of the litigants, to enter final judgments in proceedings that would otherwise be the exclusive province of Article III courts.”  Id. at 567 n. 10.  Finally, support is Supreme Court case law based on the Court’s statement that “as a personal right, Article III’s guarantee of an impartial and independent federal adjudication is subject to waiver.” Commodity Futures Trading Commission v. Schor, 478 U.S. 833, 848 (1986).

Bellingham highlighted Waldman’s failure to adequately distinguish its holding from the numerous instances where consent does cure an Article III infirmity.  Courts in other jurisdictions paid scant attention to Waldman.  But Wellness addressed issues ignored by Waldman and provides a road map of how the Supreme Court could find that the Article III protections cannot be waived by consent, thereby meaning that Waldman can no longer be ignored with impunity.

In so doing, the Seventh Circuit analyzed the complexities of Article III’s protections.  Section 1 of Article III not only protects individual interests but also is “an inseparable element of the constitutional system of checks and balances.” Stern 131 S.Ct. at 2597.  Wellness noted that “[t]he dual nature of Article III renders notions of waiver and consent more nuanced than they are in other areas….  [T]he difficulty [is] separating out the waivable personal safeguard from the nonwaivable structural safeguard.”  Wellness, 2013 WL 4441926 at *15.  Significantly, Wellnessdistinguished between consent to entry of a final order by a bankruptcy court in a core proceeding versus consent in a noncore proceeding.  Id. at *17.

In any event, the statutory scheme established by Congress for core proceedings differs in significant respects from the scheme for noncore proceedings [and magistrate judges]… Section 157(c)(2) permits a bankruptcy judge to enter final judgment in a noncore proceeding, but only if the parties consent and the district court decides to refer the matter to the bankruptcy court. Thus, a strong argument can be made that with respect to noncore proceedings Congress has left the essential attributes of judicial power to Article III courts, and so the structural interests at issue with regard to core proceedings are not present under the current statutory scheme applicable to noncore proceedings.


A Modest Proposal: Amending the Standing Orders of Reference.

Core but unconstitutional is an oxymoron. Congress created the categories of core and noncore in response to Northern Pipeline, which concluded that the 1978 Act’s grant of authority to bankruptcy courts violated Article III.  With this historical background, the Ninth Circuit found that statutorily a bankruptcy judge may only determine a claim that meets Congress’ definition of a core proceeding and “arises under or arises in title 11”(i.e., the statute limits a bankruptcy court’s jurisdiction to instances where the exercise of such jurisdiction is consistent with Article III).  In re Marshall, 600 F.3d 1037, 1055 (9th Cir. 2010).  While the Supreme Court rejected this rationale and found that a portion of the statute could and did violate Article III, the Ninth’s Circuit understanding could be implemented through (i) Congress amending the statute to limit the jurisdiction of bankruptcy courts to matters that “arises under or in title 11” (and thus not include “related to” proceedings) or (ii) the District court’s amending of standing orders of reference to withdraw the reference for Stern Proceedings.

Of the two, the district court’s amending of the standing orders is obviously far more expeditious and simpler than waiting for Congress to act (which in its present state is unlikely to ever happen on this arcane issue).  The Seventh Circuit found that the structural interests are protected in a noncore proceeding because, in addition to consent, the District Court must decide to refer the case to a bankruptcy court for a final order.

As such, a simple solution to latest Stern quandary is found by the district court’s retaining — and not automatically referring — Stern Proceedings to the bankruptcy court.  If the district court were to refer a Stern Proceeding to a bankruptcy court, the entry of a final order would be consistent with both the individual and institutional safeguards of Article III:  the district court will have referred the matter to the bankruptcy court and the parties will have consented to the proceeding.  Still, a note of caution is in order because it must be noted that Seventh Circuit in Wellness was “not express[ing] an opinion on the constitutionality of § 157(c)(2), or for that matter § 636(c)(1) which permits litigants to consent to entry of final judgment by a magistrate judge.”  Wellness, 2013 WL 4441926 at *17.

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