The Ambiguous Jurisdiction of Bankruptcy Courts


As Michael Scott once learned, screaming “I declare bankruptcy!” into the void does not resolve a solvency problem. Yet a series of recent U.S. Supreme Court cases has revealed ambiguities in bankruptcy procedure within the American legal system. The core issue lies in the organizational difference between U.S. Bankruptcy Courts and other federal courts. Bankruptcy Courts are Article I tribunals—they are created by Congress for the exclusive purpose of administering the U.S. Bankruptcy Code. But Bankruptcy Courts must often resolve subsidiary disputes before rendering their own judgments, and some of these disputes arguably belong in conventional Article III courts. The Supreme Court has recently curtailed Bankruptcy Court jurisdiction amidst a broader critique of non-Article III courts, but these decisions cannot be neatly bracketed into a narrative of the courts fighting back against Congressional overreach. In fact, the Supreme Court has framed its rulings as protecting the Congressional statutes that created the Bankruptcy Court system from arbitrary re-interpretation by judges. Farther than asserting judicial independence, the Court’s rulings have upheld the principle of the separation of powers itself.

The relationship between Bankruptcy Courts and conventional Article III courts (i.e., federal District Courts, Circuit Courts, and the U.S. Supreme Court) is difficult to delineate. While Bankruptcy Courts do have the ability to render judgment on issues outside the direct confines of the Bankruptcy Code, this power is controversial for several reasons. First, although Bankruptcy Courts are federal courts administered by appointees of the federal judiciary, Bankruptcy Judges are appointed to non-life terms. Scholars and appellate judges often cite the potential for compromised judgment resulting from this lack of financial security as a disqualification from the exercise of any Article III powers. [1] Second, although Bankruptcy Courts have original jurisdiction over bankruptcy issues, cases must be referred by regular District Courts, and those courts have the ability to engage in appellate review of Bankruptcy Court rulings under various circumstances. [2] Finally, because all bankruptcy proceedings are handled at the federal level (but in non-Article III courts), the Bankruptcy Courts’ ability to resolve related disputes in state law is challenged in some situations. [3] As a result of these conditions, appellate courts are often forced to decide how far Bankruptcy Courts can go in adjudicating disputes that stretch beyond simple claims.

Three recent Supreme Court cases attempted to further limit the powers of Bankruptcy Courts. In Stern v. Marshall (2011), the Supreme Court questioned whether a Bankruptcy Court judge had the authority to render judgment on a claim made in a state court if the issue was not a “core proceeding” of the bankruptcy dispute. In this case, a defamation suit was brought by the son of oil magnate J. Howard Marshall against Anna Nicole Smith, the patriarch’s wife at the time of his death. [4] In his majority opinion, Chief Justice Roberts was particularly concerned if Congress could claim the power to resolve what amounted to a tort in state court, “Article III could neither serve its purpose in the system of checks and balances nor preserve the integrity of judicial decisionmaking.” [5] Thus, Roberts ruled that while the relevant legislative statutes granted Bankruptcy Judges such authority, the Constitution did not.

A few years later in Law v. Siegel (2014), the U.S. Supreme Court considered the case of a debtor who engaged in an audacious fraud during bankruptcy proceedings. When Law declared bankruptcy, he listed two liens on his home, one to Northwestern Mutual, and another to ‘Lin’s Mortgage & Associates,’ an entity owned by ‘Lili Lin.’ The combined value of the liens implied that Law had no equity in his home (and thus Siegel would have no reason to pursue its sale), but issues quickly emerged with ‘Lili Lin.’ An initial Lili Lin from California responded to the court, denying any stake in the home and detailing Law’s repeated attempts to coerce her into committing fraud, but Law then insisted that this was not the real ‘Lili Lin.’ Instead, ‘Lili Lin’ lived in China and spoke no English. Despite these logistical difficulties, the new ‘Lili Lin’ remotely supported litigation to prevent the sale of Law’s home for five years, until the Bankruptcy Court finally concluded that the lien was fraudulent. The Bankruptcy Court subsequently ordered Law’s estate to reimburse the trustee for the legal fees his fraud incurred.

The Ninth Circuit Court of Appeals endorsed the Bankruptcy Court’s award of compensatory legal fees, but the U.S. Supreme Court unanimously overturned the decision, claiming that such an award fell outside the purview of the Bankruptcy Code. In limiting the Bankruptcy Courts to a narrower enforcement of the Bankruptcy Code, Justice Scalia’s opinion acknowledged the potential for “inequitable results” as a result of the ruling but insisted that maintaining the authority of Bankruptcy Courts as defined in legislation was the highest priority. [6]

The Supreme Court further constrained the power of Bankruptcy Courts to award ancillary fees in Baker Botts v. ASARCO (2015). Compensation for legal representation in Bankruptcy Court is unusual because the client is, by definition, bankrupt. To incentivize lawyers to take bankruptcy cases, the Bankruptcy Code authorizes Bankruptcy Courts to award legal fees out of the estate’s assets. The award amount is often disputed by the estate’s creditors, which can result in a separate lawsuit. [7] Here, however, ASARCO emerged out of Chapter 11 bankruptcy in excellent condition due to the work of its lawyers, so the party challenging the Bankruptcy Court’s award was the client itself. The Bankruptcy Court awarded the law firms (Baker Botts, et. al.) $120 million for their services plus $5 million for defending their applications for the fees. [8] While the primary award was obviously legal, the Supreme Court had to decide whether Bankruptcy Courts could force reimbursement for the defense of fee applications, as well. In his majority opinion, Justice Thomas ruled that Bankruptcy Courts had no such authority because the statutes governing them did not give cause to deviate from the general judicial precedent (the “American Rule”) stipulating that each side should pay its own legal fees.

Since the implementation of the current Bankruptcy Code in 1978, Article III courts have worked to define the jurisdictional complexities of Bankruptcy Courts, and these efforts are still ongoing. The cases examined here all confronted situations in which Bankruptcy Courts attempted to exercise conventional judicial functions (i.e., outside the narrow realm of administrative law) in their resolution of Bankruptcy Code disputes. While reviewing such actions, the Supreme Court weighed the conflicting goals of maintaining efficient Bankruptcy Courts and protecting the powers unambiguously assigned to Article III courts by the Constitution. However, in so doing, the Supreme Court’s assertion of that boundary did more than protect its own jurisdiction.

By limiting the power of Bankruptcy Courts, the Supreme Court upheld the separation of powers itself and may have even strengthened Congress in the process. Although these decisions restricted the scope of existing Congressional statutes, the broader principle underwriting them encourages Congress to reassert itself in two ways. First, they demonstrate that the judicial system will not re-interpret Congressional legislation to create powers unintended at the time of adoption. This should put members of Congress concerned about unaccountable bureaucrats and judges at ease. Second, it sends a signal that when Congress fails to pass the legislation necessary to clarify its intent in administrative disputes, the judiciary cannot be counted on to clean up the mess. At a certain point the training wheels must be removed, and hopefully the miscarriage of justice in Law v. Siegel will provide an impetus for Congress to start working again.

Sources:

[1] Chesley, Andrew. 2016. “The Scope of United States Magistrate Judge Authority After ‘Stern v. Marshall.’” Columbia Law Review 116 (3): 757–803. 774

[2] Behrens, Eric G. 2011. “Stern v. Marshall: The Supreme Court’s Continuing Erosion of Bankruptcy Court Jurisdiction and Article I Courts.” The American Bankruptcy Law Journal; Ft. Wayne 85 (4): 387–427. 396

[3] Patton, David W. 2018. “Bankruptcy Courts’ Authority Under § 505.” Emory Bankruptcy Developments Journal 34 (2): 643–80. 658

[4] Stern v. Marshall, 564 U.S. 463

[5] Ibid., 484.

[6] Stephen Law, Petitioner v. Alfred H. Siegel, Chapter 7 Trustee, 571 U.S. ___ (2014), 11.

[7] “Opinion Analysis: Divided Court Rules That ‘American Rule’ Bars Fees for Litigation over Attorney’s Fees in Bankruptcy.” 2015. SCOTUSblog (blog). June 16, 2015. https://www.scotusblog.com/2015/06/opinion-analysis-divided-court-rules-that-american-rule-bars-fees-for-litigation-over-attorneys-fees-in-bankruptcy/.

[8] Baker Botts, L.L.P., et. al. v. ASARCO, L.L.C., 576 US _ (2015), 13