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June 30‚ 2011
Supreme Court: Bankruptcy Courts Cannot Decide
Debtors’ State Law Counterclaims
By Kevin J. Walsh
and Ella Shenhav
In a decision that may have significant practical
implications to the practice of bankruptcy law, the U.S. Supreme Court
recently declared, on constitutional grounds, that a bankruptcy court
cannot exercise jurisdiction over a debtor’s state law counterclaims, thus
considerably limiting the ability of the bankruptcy court to fully and
finally adjudicate claims in a bankruptcy case. Stern v. Marshall,
No. 10-179 (June 23, 2011).
Stern is the latest chapter in the long-running saga
over entitlement to nearly half a billion dollars from the estate of oilman
J. Howard Marshall II. The key players are Vickie Lynn Marshall (aka Anna
Nicole Smith) and her late husband’s son, Pierce Marshall. After Vickie
filed for bankruptcy, Pierce filed a proof of claim, asserting damages due
to alleged defamation by Vickie. Vickie filed a counterclaim for tortious
interference with the inheritance she expected to receive from her late
husband. The bankruptcy court agreed with Vickie and ruled in her favor to
the tune of over $400 million. Pierce then argued that the bankruptcy court
did not have jurisdiction to decide Vickie’s counterclaim, and the district
court agreed—but accepted the bankruptcy court’s “proposed” ruling and
upheld the verdict. After the court of appeals failed to resolve the issue
to the satisfaction of the Supreme Court, the latter agreed to hear the
case.
Surprising many observers, the Supreme Court found that
although the bankruptcy court had statutory authority to hear Vickie’s
claim under 28 U.S.C. § 157, this authority is “one isolated respect” under
the Bankruptcy Code in which Congress exceeded the limitation of Article
III of the Constitution. Vickie’s counterclaim against Pierce was indeed a
“core proceeding” under the plain text of § 157(b)(2)(C), as the Court
recognized. However, because resolution of the counterclaim was not
necessary in order to adjudicate Pierce’s bankruptcy proof of claim, the
Court held that final resolution of the dissimilar counterclaim implicated
the judicial power of the United States and therefore falls under the
exclusive jurisdiction of Article III federal district court judges, rather
than Article I bankruptcy judges, who do not wield the same judicial power
as their district court colleagues.
This holding likely will have widespread ramifications in
bankruptcy cases. As recognized in the dissent in Stern, bankruptcy
proceedings in which a counterclaim will fall outside the jurisdiction of
the bankruptcy court, given the majority decision, are quite common.
Removing state law counterclaims from the scope of the bankruptcy court’s
review could cause confusion, inefficiency, waste, and a significant
backlog in the dockets of the district courts, which normally adjudicate
far fewer cases than the bankruptcy courts do, and are not equipped to
handle the caseload, which will now be channeled in their direction. The
Supreme Court answered such concerns by stating that “the fact that a given
law or procedure is efficient, convenient, and useful in facilitation
functions of government, standing alone, will not save it if it is contrary
to the Constitution.” Despite this rationale, the impact of Stern is
likely to be felt deeply throughout the federal court system, and will
negatively impact the administration of bankruptcy cases.
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