On June 23, 2011, the U.S. Supreme Court issued what has been referred to as a “bombshell” or “watershed” opinion regarding the scope of Constitutional authority that bankruptcy judges have to enter final judgments on state law claims, including fraudulent transfer causes of action.  On June 23, 2011 the U.S. Supreme Court in Stern v. Marshall issued what has been referred to as a “watershed” decision constraining the ability of Article I bankruptcy judges to issue final judgments against third parties on state law claims. Stern v. Marshall, 131 S. Ct. 2594 (2011); see In re Turner, 2011 WL 2708907 at * 4 (Bankr. S.D. Tex. 2011) (referring to Stern as a “watershed” opinion); In re Teleservices Group, Inc., __ B.R. __, 2011 WL 3610050 at * 1 (Bankr. W.D. Mich. 2011) (referring to theStern Court as having dropped a “bombshell” on the bankruptcy world).

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.