An interesting question was addressed by the Supreme Court in June of 2011 regarding the limits of bankruptcy court jurisdiction. In the case of Stern v. Marshall, the Supreme Court held that Section 157(b)(2)(c) of the Bankruptcy Code unconstitutionally violates Article III of the Constitution because it allowed non-tenured judges to render final judgments on state common law tort claims.
Bankruptcy court judges were created by statute under Article I of the Constitution. Bankruptcy judges are appointed for 14-year terms. Federal court judges have lifetime tenure and are given their powers pursuant to Article III of the Constitution. The Supreme Court determined that only Article III judges were given the power under the Constitution to enter final judgments on state court issues. Bankruptcy judges are limited to decisions on bankruptcy related matters.
Section 157(b)(2) gives the bankruptcy court jurisdiction over “core proceedings” related to the bankruptcy. One of the “core proceedings” was subsection (c) which included “counterclaims by the estate against persons filing claims against the estate.” This meant that if the debtor filed a counterclaim related to a proof of claim filed by a creditor the bankruptcy court could judge the entire matter. However, the Supreme Court has now said that if the counterclaim is a common law tort claim, the bankruptcy court can only issue proposed findings of fact and proposed conclusions of law and the actual action will have to be adjudicated by an Article III federal court judge or state court judge.
The actual facts of the Stern v. Marshall case were quite interesting in their own right. The case involved Anna Nicole Smith’s battle for the estate of her deceased elderly Texas oil millionaire husband against the millionaire’s son. Ms. Smith filed for bankruptcy while litigation was pending regarding the legitimacy of the estate’s gift to Ms. Smith. The son, Mr. Marshall, filed a proof of claim for damages for defamation and Ms. Smith filed a counterclaim for tortious interference with her gift. The bankruptcy court awarded Ms. Smith $400 million on her counterclaim. However, the Supreme Court nullified the decision because it said the bankruptcy court did not have jurisdiction over the common law tort counterclaim.
The future result of this decision will be extended and bifurcated litigation unless all parties involved consent to bankruptcy court jurisdiction.