At its heart, Stern holds that “‘the entry of a final, binding judgment by a court with broad substantive jurisdiction, on a common law cause of action, when the action neither derives from nor depends upon any agency regulatory regime’ is a power reserved in the federal system to Article III courts.”  Little Rest Twelve, Inc. v. Visan, 2011 WL 3055375 at * 8, n. 8 (S.D.N.Y 2011) (quoting Stern v. Marshall, 131 S. Ct. at 2615).

Within the context of Stern, the Supreme Court held that an Article I bankruptcy judge lacked the “constitutional authority” to enter a final judgment on a state law counterclaim brought by the bankruptcy estate against a third party even though Congress under 28 U.S.C. § 157 (b)(2)(B) had specifically designated counterclaims by a bankruptcy estate as “core” proceedings for which bankruptcy judges could enter final judgments.  Stern v. Marshall, 131 S. Ct. at 2620.  The Stern Court’s decision arose in the context of a bankruptcy judge entering a final judgment on a state law counterclaim by the estate against a third party who had filed a proof of claim against the debtor’s estate, and language in the majority opinion indicates that the Justices suggested their opinion was to be narrowly applied to that situation.  Nevertheless, with the broad sweeping language in the majority opinion, it is hard to accept that the Justices really intended their decision to be narrow in scope.  And after the decision was first entered, bankruptcy practitioners were anxious to see how the lower courts would treat the decision.

Well, after two months following the Supreme Court dropping its “bomb” on the bankruptcy courts, the dust appears to now be settling and what is revealed in its aftermath is a crater that is deep and wide.

Perhaps the most profound manifestation to date of Stern’s impact is the decision by Judge Kirscher of the U.S. Bankruptcy Court for the District of Montana in In re Blixseth, __ B.R. ___, 2011 WL 3274042 at ** 10-12 (Bankr. D. Mont. Aug. 1, 2011).  In the relevant portion of the opinion, Judge Kirscher held that because of Stern, he lacked subject matter jurisdiction over any fraudulent transfer claims.  His interpretation of Stern in connection with his interpretation of 28 USC 157 led him to the conclusion that only Article III judges can hear fraudulent transfer claims because they are fundamentally state law claims which should be adjudicated before an Article III court.  According to Judge Kirscher, bankruptcy judges don’t even have the statutory ability to enter proposed findings of fact and conclusions of law on fraudulent transfer claims.  Judge Kirscher’s opinion is certainly the correct application of Stern because Constitutionally, only Article III judges should be able to adjudicate these types of common law claims (which can result in hundreds of millions of dollars in liability) against defendants and it is a waste of litigant and judicial resources for an Article I judge to merely issue proposed findings of fact and conclusions of law to be reviewed de novo by a district court based on a cold paper record without the benefit of live witness testimony.

As correct as Judge Kirscher’s decision is in this regard, it is sure to grab the attention of Congress and the District Courts because fraudulent transfer causes of action are the “bread and butter” of bankruptcy trustees and the bankruptcy courts.  Indeed, the trustees depend on litigating fraudulent transfer actions in the bankruptcy courts because the bankruptcy courts generally provide a quick litigation schedule for them and they are able to present their cases to judges with whom they are greatly familiar, and who are likely familiar with the underlying facts from presiding over the underlying bankruptcy administration.  Yet, the Stern decision promises to flood the District Courts with these fraudulent transfer cases and to slow down resolution of these cases as they move to traditional civil dockets.  Of course, from the perspective of the non-bankruptcy practitioner who finds himself defending a client in bankruptcy court, this may be a welcome result because trustee initiated fraudulent transfer causes of action are generally regarded as nothing more than “nuisance” or “shakedown” suits; the inability of trustees to initiate these types of suits before their familiar bankruptcy judge will certainly make them think twice before filing an otherwise marginally meritorious case before a familiar judge.  From a due process perspective, this is the correct result.

Also consistent with the broad application of Stern is the thoughtful opinion of Judge Hughes from the Western District of Michigan Bankruptcy Court.  In re Teleservices Group, Inc., __ B.R. __, 2011 WL 3610050 (Bankr. W.D. Mich. 2011).  Judge Hughes pulls no punches and starts his opinion by acknowledging that Stern essentially calls into question the validity of all final orders entered by bankruptcy judges over the previous 25 years.  Judge Hughes also forms the opinion that the logical conclusion of Stern is to relegate bankruptcy judges to the functional equivalent of law clerks and court administrative officials, who do not really hold any judicial power.  Although Judge Hughes believes that the reasoning of Stern is “sound”, he expresses frustration at not having any guidance from the Court as to what exactly he can or should do with respect to administering bankruptcy estates.  After reading Judge Hughe’s decision, it is clear that a majority of bankruptcy judges probably feel the same way and they want Congress or the Supreme Court to give them some direction before they waste their resources in issuing “final” decisions upon which debtors, creditors  and defendants can have no confidence.

As for the Colorado bankruptcy judges, only Judge Brooks has had an opportunity to mention Stern.  In a footnote Judge Brooks merely mentions that the Stern decision might call into question his ability to enter a final decision concerning his ability to rule on state law issues concerning civil and criminal tort liability but concludes that because he was doing so only to rule on a Section 523 non-dischargeability complaint, he did not run afoul of Stern.  In re Graham, __ B.R. __, 2011 WL 2694146 n. 27 (Bankr. Colo. 2011).  Certainly the mention of Stern in a footnote by Judge Brooks does not give Colorado bankruptcy practitioners a meaningful indication of how Stern will be treated here so we will have to wait and see how Stern is received here.

As discussed in earlier articles, this gaming of the foreclosure system has discouraged many foreclosure investors from participating in the process and as a result, has depressed bidding prices at the foreclosure sales. The proposed amendments to the current statues that the Legislature considered last session would have clarified that foreclosure purchasers could stop this gaming of the system by forcing the junior lien investor to accept a payoff of the junior lien debt and thereby extinguish the junior lien investor’s right to redeem.

The proposed legislation passed through the Senate but a House Committee recommended that the House not consider the proposed amendments until further clarifications were made to the proposed legislation.

Hatch Ray Olsen LLC is excited to announce that the Legislature will once again consider proposed legislation that will curb substantially the current abuse of the foreclosure and redemption statutes that is being employed through the use of junior lien redemption rights as described above. The attorneys of Hatch Ray Olsen LLC are working with the Legislature and the stakeholders (i.e., mortgage lenders, title insurers, the Public Trustees, and HOAs) in this matter to ensure that the concerns that the House had last session are addressed so that Colorado’s foreclosure and redemption statutes are amended in a manner that will promote participation and full bidding at the Public Trustee foreclosure auctions, and eliminate backroom foreclosure auctions that are currently happening in the offices of junior lien holders.

The current gaming of Colorado’s foreclosure system is somewhat complicated but takes advantage of Colorado’s unique foreclosure and redemption system.  In Colorado, after a bank that holds a first position deed of trust on a property has foreclosed that deed of trust at a Public Trustee’s sale, any creditor that holds a junior lien on the property that was foreclosed, has the right to “redeem” the property from foreclosure.  Typically, a junior lienor redeems the property by paying the Public Trustee the amount of money that the property sold for at the foreclosure auction.  This allows the junior lienor to rightfully obtain the foreclosed property so that the junior lienor can attempt to be repaid the debt that is owed to it, assuming that there is sufficient equity in the foreclosed property to satisfy the junior lienor’s debt.

However, in the last couple years, some foreclosure investors have found that they can abuse these redemption statutes for the purpose of obtaining a foreclosed property at what they perceive to be a discounted price.  Because most homeowners who are in default on their first mortgages, are typically also in default on their HOA dues, many of the homeowners’ properties are encumbered by HOA liens that are junior to the foreclosing bank’s mortgage (or deed of trust).

Some foreclosure investors believe that they can obtain a competitive edge in the foreclosure market by purchasing an assignment of these junior HOA liens from the relevant homeowners’ associations.  Sometimes these foreclosure investors will pay a substantial premium to the homeowners’ association for the assignment of a particular HOA lien.  For instance, in some cases these junior HOA lien investors have paid $15,000 for an HOA lien that secured a debt of only $3,000.

With the assignment of their HOA lien in hand or all but guaranteed, these junior HOA lien investors will show up at a Public Trustee’s foreclosure sale and publicly announce to all that they possess the HOA lien for a particular property.  This in turn discourages potential investors from bidding for that property because if they prevail at the auction, they know that this junior HOA lien investor will redeem the property from them.  As a result, a property that would have otherwise sold at a competitive foreclosure auction sells at a discounted price;  which is precisely why the junior HOA lien investor purchased the HOA lien in the first place.

If a foreclosure investor does purchase a property at auction and is later faced with a junior HOA lienor who attempts to redeem the property, the foreclosure investor may try prevent the redemption by tendering a payoff to the junior HOA lienor of the debt that is secured by the lien.  One would think that these junior HOA lienors would be happy to be paid the debt that is secured by their HOA lien.  However, most often these junior HOA lien investors refuse to accept the payment and push forward with their redemption efforts.  The attorneys at Hatch Ray Olsen have successfully defeated these junior HOA lien investors in litigation and have forced them to accept the payment of the debt that is secured by their HOA lien.

However, the need to engage in litigation to prevent this abuse of the foreclosure system may soon be coming to an end.  Senator Kevin Lundberg has introduced Senate Bill 10-093 which seeks to clarify the existing law to specifically state that any junior lienor must accept the payment of the debt that is secured by their junior lien and when that payment is made, the junior lienor no longer has a redemption right.

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