United States Supreme CourtIn a case that could have upended the bankruptcy and magistrate court systems, the Supreme Court took a pragmatic approach yesterday when it held in Wellness Int’l Network, Ltd. v. Sharif that with “knowing and voluntary consent” of the parties, a bankruptcy court could adjudicate a so-called “Stern claim,” which would otherwise be outside the scope of its constitutional power.  The Court’s 2011 ruling in Stern v. Marshall held that Article III of the Constitution “forbids bankruptcy courts to enter a final judgment on claims that seek only to augment the bankruptcy estate and would otherwise exist without regard to any bankruptcy proceeding.” That conclusion extended even to claims that were expressly within Congress’ grant of core jurisdiction to the bankruptcy courts, which were denominated “core but unconstitutional.”

Since the 2011 Stern decision, practitioners and courts have struggled to determine the scope of a bankruptcy court’s authority with regard to such Stern claims.  In Executive Benefits Ins. Agency v. Arkison, decided last June, the Supreme Court dodged the opportunity to construe the breadth of “core but unconstitutional” or to decide whether a party could agree, either by express or implied consent, to a bankruptcy court’s rendering a final judgment that would otherwise be unconstitutional.  Instead, a unanimous Court ruled that the procedural history of the case mooted the dispute by effectively providing a final judgment by an Article III court.

In Wellness, the Supreme Court was again confronted with questions on the scope on the constitutional power of a bankruptcy court and the impact of consent on the breadth of that authority.  The Court was asked to determine whether one of the most fundamental matters that bankruptcy courts have traditionally resolved—what constitutes “property of the estate” of a debtor – is within a bankruptcy court’s constitutional judicial power.

The debtor in Wellness commenced his bankruptcy case after losing a lawsuit with a creditor in a non-bankruptcy litigation.  The dispute at issue concerned whether particular assets were “property of the estate” under Section 541 of the Bankruptcy Code as maintained by the Trustee or whether the Trustee had only “bare legal title” to property held in trust by the debtor for other family members.

The questions before the Supreme Court were whether the bankruptcy court had constitutional judicial power to render final judgment on the “property of the estate” question and, if not, whether that authority had been legally conferred by the express or implied consent of the parties.  Justice Sotomayer, writing for the five justice majority, did not address whether the claim at issue in Wellness was in fact a Stern claim, but rather went directly to the conclusion that parties can knowingly and voluntarily consent to the adjudication of a Stern claim by a bankruptcy court.  The Court relied heavily on its opinion in CFTC v. Schor, 478 U.S. 833 (1986) wherein it addressed Congress’ authority to grant the CFTC the ability to hear counterclaims.  Schor held that the “right to adjudication before an Article III court is ‘personal’ and therefore ‘subject to waiver.’”  The Court was also influenced by cases involving the scope of a magistrate’s authority wherein consent was the dispositive issue.

The Court held that permitting parties to consent to bankruptcy court adjudication of a Stern claim would not “impermissibly threaten the institutional integrity of the judicial branch.”  Such analysis, Justice Sotomayor noted, should not turn on “formalistic and unbending rules” but rather on the practical impact that the practice will have on the constitutionally assigned role of the judiciary.  The Court noted that between October 2013 and September 2014, more than 950,000 cases were filed in the bankruptcy courts —more than the number of cases filed in the district courts and circuit courts combined.  The Court felt that consent posed no threat to the federal judiciary because a bankruptcy court still possess no “free-floating authority to decide claims traditionally held by Article III courts.”  Instead, bankruptcy courts are at all times operating under the authority of an Article III court, and there is no indication that Congress is attempting to usurp the power of the judiciary by allowing bankruptcy courts to adjudicate Stern claims.

Finally, regarding the propriety of consent, the Court concluded that its decision is consistent with Stern.  Noting that Stern turned on whether the litigant truly consented to resolution of his claim in a non-Article III setting, the Court held that Stern does not therefore govern the question of valid consent.  Indeed, the Court continued, to hold that Stern does not permit knowing and voluntary consent to bankruptcy court adjudication of a Stern claim is contrary to Stern’s description of its holding as narrow—one that does “not change all that much.”

The final portion of the Wellness opinion held that the knowing and voluntary consent need not be express but can be implied.  This, the Court held, is consistent with the magistrate system and the language of the Bankruptcy Code.  The test is “whether the litigant or counsel was made aware of the need for consent and the right to refuse it, and still voluntarily appeared to try the case before the non-Article III adjudicator.”  The Court, however, cautioned that it is a good practice for bankruptcy courts to obtain express statements of consent to ensure irrefutability.

Several additional opinions were written in this case.  Justice Alito concurred in part and concurred in judgment but would not have decided the issue of implied consent because he argued it was not before the Court.  The principal dissent was penned by Chief Justice Roberts with Justice Scalia joining and Justice Thomas joining in part.  The dissents suggested that the claim at issue in Wellness, a dispute over what constitutes property of the bankruptcy estate, was not actually a Stern claim; therefore, the Court did not need to reach an opinion on consent.  Justice Roberts then went on to attack the majority decision based on his view that parties have no right to compromise structural separation of powers or “agree to an exercise of judicial power outside Article III.”  Finally Justice Thomas weighed-in with an analysis of whether a Constitutional violation actually occurred here.

Much was made by amici and commentators about the potential impact that an opposite ruling would have had on the future of the current magistrate system—one built on consent.  Those concerns have been allayed by this decision.  Furthermore, the permissibility of implied consent will provide bankruptcy courts the flexibility necessary to maintain the status quo.  Finally, we are intrigued by the principal dissent’s assertion that the claim in Wellness was not a Stern claim.  Perhaps this foreshadows a future narrowing of what the Court considers to be a Stern claim.  There is no doubt that Stern will continue to spin a progeny of cases which will further shape the bankruptcy court system.