The Supreme Court’s recent (June 2011) opinion in Stern v. Marshall left open questions regarding the scope of a bankruptcy court’s jurisdiction to enter final judgments in adversary proceedings. Another recent case from the Ninth Circuit Court of Appeals, Executive Benefits Insurance Agency v. Arkison, shed additional light on the issue. The Ninth Circuit interpreted Stern itself. It held that a bankruptcy court cannot enter final judgment on a claim to avoid a fraudulent conveyance against a non-creditor to a bankruptcy estate.

Many fraudulent conveyance claims involve similar sets of circumstances. In Executive Benefits Agency v. Arkison, a debtor transferred assets (insurance commissions) to a recently formed company. The debtor then filed for bankruptcy. The Chapter 7 Trustee then sought recovery from the recently formed company (which was a non-creditor) by filing an adversary proceeding, to try to recover the insurance commissions for the benefit of the estate. During the litigation in bankruptcy court, the court granted the Trustee’s motion for summary judgment in the amount of $373,291 against the transferee (the company). The transferee appealed to the Ninth Circuit, disputing the authority of the bankruptcy court to enter a final judgment under Stern.

The issues were complex, but basically the Ninth Circuit held that fraudulent transfers do not fall within the “public right” exception laid out in Stern. There was an issue regarding the ability of bankruptcy courts to render final judgments on fraudulent transfers under the Bankruptcy Code as opposed to final judgments on transfers arising under state law. The Ninth Circuit held that there should not be a blanket “public right” classification for any claim based on federal law.

The Court went on to say that, although federal law authorizes bankruptcy judges to “hear and determine all cases under Title 11 and all core proceedings arising under Title 11,” the Constitution prohibits bankruptcy judges from entering a final judgment in core proceedings when the primary cause of action is not against a creditor to the estate.

The Ninth Circuit, having found an absence of authority for a bankruptcy court to enter a final judgment against a non-creditor on a fraudulent transfer claim, also held that another section of the Bankruptcy Code (§157) permits bankruptcy courts to submit reports and recommendations to the district courts in core proceedings. The Court was aware that this holding created some conflict and confusion among the other circuits, most notably the Sixth Circuit.

Although the Ninth Circuit found that a bankruptcy court lacked the authority to enter a final judgment in such a case, it nevertheless affirmed the district court’s opinion. It held that the defendant waived its right to an Article III hearing by litigating in the bankruptcy court without having raised any objection to that court’s jurisdiction to hear the fraudulent transfer claim. Since the Supreme Court issued its opinion in Stern in June 2011, there has been much dispute and discusson on the ultimate impact of the Stern opinion. Many voices have weighed in on this issue. With the Ninth Circuit’s recent ruling, it is now clear that litigants must be aware of how their circuit is interpreting Stern so that no rights or benefits are accidentally waived.

In the Ninth Circuit, following the Executive Benefits decision, a bankruptcy court’s constitutional authority may not extend to entering judgment on fraudulent transfer claims against a noncreditor. It seems advisable now that plaintiffs asserting fraudulent transfer claims in bankruptcy should either (1) bring their claims in the first instance before the district court or (2) request that the bankruptcy court propose findings of fact and conclusions of law, rather than enter a final judgment. In addition, defendants in all jurisdictions should be careful not to waive any Article III objections.

These types of litigation decisions are of particular concern to plaintiffs who may benefit from asserting fraudulent transfer claims before bankruptcy courts, which routinely hear such claims and will be experienced with handling them. In the end, it all comes down to a cost-benefit analysis. Every creditor will have to make his own decision in this regard. The convenience of bringing such litigation before a bankruptcy court will need to be weighed against the procedural issues that may arise because the bankruptcy court cannot issue the final judgment on such claims.

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