In 2011, the Supreme Court decided Stern v. Marshall, 564 U.S. ___, 131 S. Ct. 2594 (2011), which gave voice to the Court’s grave concerns about the constitutional limits of bankruptcy court jurisdiction and raised several questions that have confounded courts and lawyers for three years. Last week, the Supreme Court issued its first follow-up ruling, answering some of those questions and clarifying how bankruptcy courts are to handle so-called Stern claims. Despite that guidance, the opinion leaves several important questions unanswered.

Federal bankruptcy statutes distinguish between “core” matters (that can be heard and determined by a bankruptcy court) and “non-core” matters (where final judgment must be entered by a U.S. district court judge appointed for life—an “Article III judge”). Stern created a third category: matters that are statutorily designated as core but that can only be adjudicated by an Article III judge. Bankruptcy judges, who are not appointed by the President, are not confirmed by the Senate, and serve only 14-year terms, are not imbued with full constitutional authority.

Last week’s decision in Executive Benefits Insurance Agency v. Arkison, No. 12-1200, 2014 WL 2560461 (June 9, 2014), a case that originated in Washington State, again addressed what matters can be finally decided by bankruptcy judges and what matters must be decided by Article III judges. Immediately before filing for bankruptcy, the debtor transferred assets to Executive Benefits Insurance Agency (EBIA). The chapter 7 trustee sued EBIA, alleging a fraudulent transfer. EBIA lost in the bankruptcy court and appealed to the U.S. district court, which affirmed the bankruptcy court’s ruling. After EBIA appealed to the Ninth Circuit Court of Appeals but before the appellate court had ruled, the Supreme Court issued its ruling in Stern, and EBIA for the first time argued that the bankruptcy court had been constitutionally incapable of entering final judgment on the fraudulent transfer claims. The Ninth Circuit agreed that the trustee’s claims were Stern claims but concluded that EBIA had consented to final adjudication by the bankruptcy court. Id. at *1.

The Supreme Court affirmed the Ninth Circuit, but on very different grounds. In a unanimous opinion written by Justice Thomas, the Court acknowledged that Stern claims create a statutory gap: “By definition, a Stern claim may not be adjudicated to final judgment by the bankruptcy court, as in a typical core proceeding. But the alternative procedure, whereby the bankruptcy court submits proposed findings of fact and conclusions of law, applies only to non-core claims.” Id. at *7.

Whereas the Ninth Circuit upheld the bankruptcy court’s judgment based on consent, the Supreme Court expressly declined to decide whether parties can consent to bankruptcy court adjudication of Stern claims. Id. at 4 n.4. Instead, the Supreme Court noted that the 1984 law that created the core/non-core distinction contained a severability clause stating that if any provision was held invalid, “‘the remainder of this Act . . . is not affected thereby.’” Id. at *7 (citation omitted). Applying the severability clause, the Court determined that the trustee’s Stern claim against EBIA was entitled to the same treatment as non-core claims that are related to a bankruptcy case: i.e., the claim can be heard by a bankruptcy judge, who must submit proposed findings of fact and conclusions of law to an Article III judge, who then conducts a de novo review before entering a final judgment. In EBIA’s case, the Supreme Court concluded that the district court had already conducted a de novo review when it heard EBIA’s appeal. Despite the fact that the precise procedure was different than what the Supreme Court requires for Stern claims—the district court had technically heard an appeal rather than simply proposed findings and conclusions of the bankruptcy court—the result was the same, and therefore, the Supreme Court affirmed the Ninth Circuit’s ruling.

Executive Benefits Insurance Agency did not, however, address one of the central questions raised by Stern: whether parties can consent to the final adjudication of a Stern claim by a bankruptcy judge. The Fifth, Seventh and Ninth Circuit Courts of Appeal have already split on this issue. This not only is an important issue for parties in bankruptcy proceedings but also has potentially large ramifications for the magistrate judge system, where parties often consent to entry of a final judgment by magistrate judges, who are, like bankruptcy judges, not Article III judges.

© 2014 Perkins Coie LLP