January 28, 2015 - Earlier this month the Supreme Court held oral argument on an appeal arising out of the Seventh Circuit Court of Appeals that revisits the thorny and frequently litigated issue of bankruptcy court jurisdiction post-Stern v. Marshall.

In Wellness Int’l Network v. Sharif, the Seventh Circuit Court of Appeals held that (i) a bankruptcy court lacks constitutional authority to issue a final judgment on the resolution of a claim involving state common law issues, and (ii) that a party’s consent to bankruptcy court jurisdiction cannot cure a constitutional deficiency.  727 F.3d 751 (7th Cir. 2013).

The debtor, Richard Sharif, filed for Chapter 7 relief and the petitioner, Wellness International Network Ltd., filed an adversary proceeding in the bankruptcy court to collect on a pre-petition judgment against Sharif, alleging that certain funds not reported on Sharif’s bankruptcy petition should be part of the bankruptcy estate under an alter ego theory of liability.  Following Sharif’s failure to comply with discovery orders in the adversary proceeding, the Bankruptcy Court entered a default judgment in favor of Wellness.  On appeal, Sharif argued that the Bankruptcy Court lacked constitutional jurisdiction to enter final judgment on Wellness’ claim.  The Seventh Circuit held that because Wellness’ claim, based on alter-ego liability, was rooted in state common law, it was not sufficiently related to the claims-allowance process to permit bankruptcy court jurisdiction.  The Seventh Circuit also rejected Wellness’ argument that Sharif had waived his Stern objection by consenting to bankruptcy court jurisdiction and failing to raise the issue in the Bankruptcy Court.

The Supreme Court granted certiorari to consider the following issues:

  1. Does the presence of a subsidiary state property law issue in an action brought against a debtor to determine whether property in the debtor’s possession is property of the bankruptcy estate mean that such action does not “stem[] from the bankruptcy itself” and therefore, that a bankruptcy court does not have the constitutional authority to enter a final order deciding that action; and
  2. Does Article III permits the exercise of the judicial power of the United States by the bankruptcy courts on the basis of litigant consent, and if so, whether implied consent based on a litigant’s conduct is sufficient to satisfy Article III.

At oral argument, Justice Breyer echoed the arguments put forth by counsel for Wellness and supported by the Solicitor General as amicus curiae, that removing questions of what property constitutes the bankruptcy estate — “the most fundamental thing imaginable” — from the jurisdiction of the bankruptcy court would disrupt “the constitutional grant to Congress to make uniform laws of bankruptcy.”  However, Justice Roberts expressed concern that allowing bankruptcy judges to decide certain state law issues “takes out of the Federal courts our constitutional birthright to decide cases and controversies under Article III.

The Justices also spent some time considering the effect of any decision on lower courts, in light of the confusion that stemmed from Stern and its progeny.  Justice Scalia turned to the parties to ask which of the two questions presented to the Court “is the prettier question . . . or the one that you think has more real world effect?”  Justice Kennedy followed up, “are the bankruptcy courts more confused by Question 1 or Question 2?”  Justice Breyer suggested that there was no precedent of the Court that prohibited it from deciding both questions.

It is particularly difficult to speculate on the outcome of this oral argument because the Justices that joined the majority decision in Stern v. Marshall (Justices Roberts, Scalia, Kennedy, Thomas and Alito) did not indicate a strong preference for either side at oral argument.  We will report back when a decision is entered, which should occur before the end of the Supreme Court’s term in June 2015.