Eastern District of Kentucky U.S. District Court Judge David L. Bunning holds that “[t]aking the specific facts and issues in [Stern v. Marshall, 564 U.S. ----, 131 S. Ct. 2594, 2605 (2011)] and [Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989)] into consideration, in addition to the Supreme Court’s deliberate attempt to limit the scope of its holdings in both cases, this Court cannot extend the holding of Stern to fraudulent conveyance and preference actions.” Official Committee Of Unsecured Creditors Of Appalachian Fuels, LLC v. Energy Coal Resources, Inc. et al., No. 11-00131-DLB Dkt No. 13 (E.D. Ky April 18, 2012)
Developments in Bankruptcy Transfer Avoidance Law and Practice
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Background of the Proceedings
June 22, 2011, the Official Committee of Unsecured Creditors of Appalachian Fuels, LLC (“the Committee”) filed the bankruptcy adversary proceeding at issue against 37 defendants. As subsequently amended, the complaint sought, inter alia, ”to (1) avoid and recover funds that were allegedly fraudulently or preferentially transferred to the Defendants; (2) recover damages arising out of Defendants’ corporate waste, breaches of fiduciary duty, civil conspiracy, unjust enrichment, and aid and abetment of other Defendants in doing the same; and (3) recover damages arising from the legal malpractice and conflicted representation committed by Appalachian Fuels’ attorneys.”
Between October 31 and November 10, 2011, less than three months after the Amended Complaint was filed, 30 of the 37 defendants filed motions to withdraw the reference. The plaintiff Committee also filed a “Conditional Motion to Withdraw the Reference.”
Stern Intended to be Narrow
Judge Bunning starts his interpretation of Stern with the conclusion that “the Supreme Court clearly intended to, and did in fact, limit the application of its holding.” In support of this conclusion, he points out the narrow scope of the actual holding in Stern.
Notably, the Court did not find that the bankruptcy court lacked constitutional authority to enter a final judgment on all state law counterclaims. See id. Further, the Court emphasized that its holding would not “meaningfully change the division of labor” under § 157. Id. Most importantly, “nothing in the Supreme Court’s opinion actually limits a bankruptcy court’s authority to adjudicate the other ‘core proceedings’ identified in section 157(b)(2).” In re Safety Harbor Resort & Spa, 456 B.R. at 715. Indeed, one bankruptcy court has stated that “to broadly apply Stern’s holding is to create a mountain out of a mole hill.” In re USDigital, Inc., 461 B.R. 276, 292 (Bankr. D. Del. 2011).
Judge Bunning next acknowledges that other courts have concluded that the reasoning of the Supreme Court in Stern is inconsistent with the Court’s intent to limit the holding. Judge Bunning attributes this perceived internal inconsistency in Stern to a misinterpretation of the Supreme Court’s referencein Stern to its decision in Granfinanciera:
Despite the Supreme Court’s intention to limit the application of its holding, several courts have expressed uncertainty about Stern’s effect on the bankruptcy court’s authority to enter final orders and judgments in other statutorily defined core proceedings. See e.g., In re Appleseed’s Intermediate Holdings, LLC, No. 11-807, 2011 WL 6293251 (D. Del. Dec. 15, 2011); Boyd, LLC, 2011 WL 5509873. Arguably, the Supreme Court’s reliance on Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989)6 has called into question whether bankruptcy courts can continue to enter final orders and judgments in fraudulent conveyance claims. In Stern, the Court explained that Granfinanciera’s “distinction between actions that seek ‘to augment the bankruptcy estate’ and those that seek ‘a pro rata share of the bankruptcy res’ reaffirms that Congress may not bypass Article III simply because a proceeding may have some bearing on a bankruptcy case … .” Stern, 131 S. Ct. at 2618 (quoting Granfinanciera, 492 U.S. at 56) (internal citations omitted) (emphasis in the original)). Moreover, the Court stressed that the “question is whether the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” Id. Many courts have viewed this language as a “new limit on the Court’s constitutional authority to finally resolve other ‘core’ proceedings, such as fraudulent conveyance or preference actions.” In re Safety Harbor Resort & Spa, 456 B.R. at 717.
However, despite the reliance on Granfinanciera in Stern, the fact still remains that the sole issue in Granfinanciera was whether defendants who had not filed a proof of claim against the bankruptcy estate had a Seventh Amendment jury trial right in light of statutory authority that allowed a non-Article III tribunal to adjudicate the claims against them. Granfinanciera, 492 U.S. at 50 (“We are not obliged to decide today whether bankruptcy courts may conduct jury trials in fraudulent conveyance suits brought by a trustee against a person who has not entered a claim against the estate, either in the rare procedural posture of this case or under the current statutory scheme. Nor need we decide whether, if Congress has authorized bankruptcy courts to hold jury trials in such actions, that authorization comports with Article III when non-Article III judges preside over the actions subject to review in, or withdrawal by, the district courts. … The sole issue before us is whether the Seventh Amendment confers on petitioners a right to a jury trial in the face of Congress’ decision to allow a non-Article III tribunal to adjudicate the claims against them.” (internal citations omitted)). Furthermore, Granfinanciera has been the law for over twenty years, and it was not until after the Court’s decision in Stern that the bankruptcy court’s authority to enter final orders and judgments in fraudulent conveyance or preference actions has been challenged. In re Safety Harbor Resort & Spa, 456 B.R. at 717.
Avoidance Actions are Hard Core … Core Squared … the Core of Core
Judge Bunning distinguishes the counterclaim addressed in Stern from avoidance actions. He hints that the counterclaim in Stern really was only artificially, by statutory designation “core”. Avoidance actions, on the other hand, meet the fundamental criteria for being “core”.
Taking the specific facts and issues in Stern and Granfinanciera into consideration, in addition to the Supreme Court’s deliberate attempt to limit the scope of its holdings in both cases, this Court cannot extend the holding of Stern to fraudulent conveyance and preference actions. The statutorily core claim examined in Stern was a counterclaim based on state tort law and was “in no way derived from or dependent upon bankruptcy law.” See Stern, 131 S. Ct. at 2618. In the present proceeding, Plaintiff’s fraudulent conveyance and preference claims “arise under” the Bankruptcy Code, or at least, “arise in” a bankruptcy case. See 11 U.S.C. §§ 544, 547, 548, 550. The Stern decision itself acknowledged that whether a matter is core requires a consideration of “whether the action at issue stems from the bankruptcy itself” or is “derived from or dependent upon bankruptcy law … .” Stern, 131 S. Ct. at 2618. Moreover, but for the bankruptcy, Plaintiff could not assert the fraudulent conveyance and preference claims against Defendants. See In re Heller Ehrman LLP, No. 08-32514, 2011 WL 4542512, at *5 (Bankr. N.D. Cal. Sept. 28, 2011) (citing In re Mankin, 823 F.2d at 1307 n.4) (Fraudulent transfer claims “cannot exist but for the debtor’s insolvency, its inability to pay debts as they become due, or its unreasonably small capital–conditions which generally result in a bankruptcy.”). Accordingly, Plaintiff’s fraudulent transfer and preference claims are statutorily defined core claims to which the holding of Stern does not apply, and therefore the Bankruptcy Court has authority to enter final orders and judgments on such claims pursuant to 28 U.S.C. § 157(b)(1).
No “Unconstitutionally Core” No Man’s Land
Although not required for his holding, Judge Bunning concludes his Stern analysis by rejecting the argument that Stern, if interpreted broadly, would not allow the bankruptcy court even to issue proposed findings of fact and conclusions of law.
Finally, Defendant BB&T, who has filed a response in opposition to Plaintiff’s and moving Defendants’ motions to withdraw, argues that Stern has created a “no-man’s land” of statutorily defined core claims that cannot be tried at all in the federal court system absent some other jurisdictional basis, because the Bankruptcy Court is not statutorily empowered to treat a core claim in the same manner as a claim falling within 28 U.S.C. § 157(c)(1), i.e., a non-core claim. Thus, BB&T argues that if the Court does not sever the core claims against BB&T and allow them to remain in the Bankruptcy Court, the Court must dismiss these claims against BB&T for lack of jurisdiction as part of a withdrawal of the remainder of the case.7 This argument is without merit.
This Court’s jurisdiction over bankruptcy matters stems from 28 U.S.C. § 1334, not § 157. Pursuant to § 1334, the Court has original jurisdiction over bankruptcy cases and all civil proceedings “arising under title 11, or arising in or related to cases under title 11.” § 157(a) then allows this Court to refer actions within its bankruptcy jurisdiction to the bankruptcy judges of this district. Thus, BB&T’s argument that the core claims against it must remain in Bankruptcy Court or be dismissed from this Court for lack of jurisdiction is wholly incorrect. If this Court does not have jurisdiction over this proceeding pursuant to § 1334, then the Bankruptcy Court also lacks jurisdiction to hear the case.
BB&T’s argument also raises an issue that has recently been addressed in several bankruptcy cases post-Stern, namely that if there are statutorily defined core claims that the bankruptcy courts cannot finally adjudicate, there is no statutory authority to allow them to submit proposed findings of fact and conclusions of law to the district court on such claims. This argument is unpersuasive and has been repeatedly rejected by numerous bankruptcy and district courts.
In Stern, the Supreme Court specifically stated that the “removal of counterclaims such as debtor’s from core bankruptcy jurisdiction does not meaningfully change the division of labor in § 157.” Stern, 131 S. Ct. at 2620. Since Congress delegated broader authority to bankruptcy courts in core matters than in non-core matters, including the authority to hear and determine all cases and enter appropriate orders, it simply would not make sense to preclude bankruptcy courts from also submitting proposed findings of fact and conclusions of law to the district court on core matters. “Removing fraudulent conveyance actions from core bankruptcy jurisdiction, and also determining bankruptcy courts could not enter proposed findings of fact and conclusions of law on such actions, would meaningfully change the division of labor in the statute between bankruptcy and district courts.” In re Heller Ehrman LLP, 464 B.R. 348, 355-56 (N.D. Cal. Dec. 13, 2011). Moreover, as stated above, § 157(a) allows district courts to refer actions within its bankruptcy jurisdiction to the bankruptcy judges of their districts, so the distinction between core or non-core is immaterial. Indeed, several courts have reached this same conclusion. See e.g., In re Rothstein, Rosenfeldt, Adler, P.A., No. 11-62612, 2012 WL 882497, at *3 (S.D. Fla. Mar. 14, 2012) (“The majority of district and bankruptcy courts that have addressed this argument conclude that what is certain is that the Supreme Court did not intend to deprive the bankruptcy courts of any role in dealing with fraudulent conveyance actions.”); In re Tolliver, 464 B.R. 720, 734-35 (Bankr. E.D. Ky. Feb. 2, 2012) (“The Court expressly rejects the conclusion … that it has no statutory authority to render findings of fact and conclusions of law for core proceedings that it may not constitutionally hear.”); Adelphia Recovery Trust v. FLP Group, Inc., No. 11-6847, 2012 WL 264180, at *6-7 (S.D.N.Y. Jan. 30, 2012) (holding that bankruptcy courts may issue proposed findings of facts and conclusions of law in fraudulent transfer actions); In re The Mortgage Store, Inc., No. 11-0439, 2011 WL 5056990, at *6 (D. Haw. Oct. 5, 2011) (“The court has little difficulty in finding that Congress, if faced with the prospect that bankruptcy courts could not enter final judgments on certain “core” proceedings, would have intended them to fall within 28 U.S.C. § 157(c)(1) granting bankruptcy courts authority to enter findings and recommendations.”).