US Supreme Court has heard argument in, and has “under submission” (awaiting Court ruling) on Court’s THIRD case on jurisdiction of Bankruptcy Courts since 2011
Since 2011, the Supreme Court has decided two cases relating to the constitutional authority of Bankruptcy Courts to enter final judgments in proceedings that are outside the resolution of the debtor-creditor relationship and that seek to augment the bankruptcy estate. Stern v. Marshall, 131 S. Ct. 2594 (2011) and Executive Benefits v. Arkison, 134 S. Ct. 2165 (2014). In January 2015, the Supreme Court heard arguments in its third bankruptcy jurisdiction case in four years. Wellness International v. Sharif, No. 13-935, places at issue both the constitutional authority of the bankruptcy court to enter final judgment that a chapter 7 debtor is the alter ego of a trust for which the debtor is the trustee but not a beneficiary, as well as the necessity and character of consent to enter such a final judgment.
The pivotal issue in Sharif is whether a state law alter ego claim against the chapter 7 debtor is a Stern claim. Depending on the Court’s disposition of this issue, it may not reach the issue of consent.
Petitioner Wellness International has a long history of chasing Debtor Sharif, including obtaining default judgment against him as a plaintiff in Texas, which led to discovery in aid of collection efforts. Sharif allegedly evaded answering discovery and ultimately filed a chapter 7 petition. Debtor failed to list assets that he contends are assets of a trust his mother created and for which Debtor serves as trustee and his sister is the beneficiary. He testified about these assets, answered discovery relating to these assets but did not escape Wellness’s complaint objecting to his discharge. Wellness included as Count V in its complaint a claim for determination that the trust is the alter ego of the Debtor and that trust assets are property of the estate pursuant to §541.
The parties do not dispute that a debtor’s legal title over trust assets does not render those assets property of the estate. 11 U.S.C. §541(d).
From this starting point, the parties’ views diverge. Unsurprisingly, the manner in which the parties frame the dispute is markedly different. Wellness presents its position in terms of the jurisdiction of the Bankruptcy Court to decide what is property of the estate. It asserts that the Bankruptcy Court indisputably has exclusive jurisdiction over property of the estate, which only arises when the Debtor filed his bankruptcy petition. Thus, a dispute with the Debtor over what is and what is not property of the estate "stems from bankruptcy," coining a phrase from Stern, and could only arise post-petition because the estate is created solely by the filing of a petition. §541(a). Thus, according to Wellness, the resolution of the alter ego theory derives entirely from §541. That state law is determinative does not transform the Bankruptcy Code action into a state law action, Wellness argues, if for no other reason than long-standing bankruptcy jurisprudence holds that the debtor’s interest in property in bankruptcy is defined by state law.
In contrast, Debtor characterizes Count V solely as a common law alter ego claim that seeks to extinguish property interests of third parties (the trust and the sister) and to augment Debtor’s estate by those trust assets, much like a fraudulent conveyance action. Because Debtor held bare legal title to the assets in trust, they never become part of the estate, Debtor argues, and because Wellnesse’s effort to augment the Debtor’s estate does not derive from or depend on bankruptcy law, Stern holds that the Constitution reserved these claims in the federal system to Article III courts rather than tribunals controlled by Congress or by the Executive. Leaning heavily on the reasoning of Stern upholding the separation of power between the branches of government, the Debtor argues that Count V is a Stern claim because, although it appears to arise under the rubric of §541, it nonetheless is a common law claim that seeks to augment the estate with assets owned by a third party. As such, the Bankruptcy Court did not have jurisdiction to enter final judgment.
The Seventh Circuit held in favor of the Debtor on this first issue. Its resolution in the Supreme Court may turn on whether the Court accepts Wellness’s characterization of Count V as a core matter stemming from §541 or the Debtor’s characterization that Count V is at most non-core as a purely state law claim that seeks to augment the estate with property in which third parties have an interest.
The second issue, which Wellness contends only arises if the Supreme Court concludes that Count V is a Stern claim, is whether the Bankruptcy Court could properly exercise the judicial power of the United States by the litigants’ consent and, if so, whether implied consent is sufficient to satisfy Article III. Wellness argues that the Debtor admitted that the entire adversary proceeding was core and that the Debtor never raised the Stern claim until well into briefing at the Seventh Circuit. Wellness also argues that Article III protects primarily "personal" rights as opposed to "structural" rights and that personal rights are subject to waiver. Wellness contends that Article III is not structurally at issue because the Bankruptcy Court was operating within the judicial branch and exercising jurisdiction over Stern claims upon referral and with the litigants’ consent.
Not so, proclaims the Debtor, who argues that the structural Article III issue may not be cured by consent, which may only be given expressly. F.R.B.P. 7012(b). The nature of the Article III violation is by definition structural, according to the Debtor, because of the separation of powers and the right of an individual to an independent judiciary in certain cases, not judges subject to legislative and executive manipulation. Accordingly, the violation of Article III could not be waived and was not waived.
The Court heard argument in January and is expected to render a decision before the end of the term.
This article was written by C. Lee and appeared in American Bankruptcy Institute Consumer Bankruptcy Committee e-newsletter in March 2015