Spring 2012 • Issue 43, page 1

Stern v. Marashall: Uncertain Reach & Implications

By Chemerinsky, Erwin*

In Stern v. Marshall, 131 S. Ct. 2594 (2011), the Supreme Court held that bankruptcy courts cannot issue final judgments on state law counterclaims even though they are “core proceedings” under §157 of the Bankruptcy Act. The reach and implications of Stern v. Marshall are uncertain and creating great confusion in bankruptcy proceedings across the country.

The case received media attention because Vickie Lynn Marshall, also known as Anna Nicole Smith, had married a much older man, J. Howard Marshall. Although he lavished gifts and significant sums of money on Vickie during their courtship and marriage, J. Howard did not include anything for Vickie in his will. Before J. Howard passed away in August 1995, Vickie filed suit in Texas probate court, claiming that Pierce Marshall—J. Howard’s younger son—fraudulently induced his father to sign a living trust that did not include her. She maintained that J. Howard meant to leave her half of his estate. Pierce denied any fraudulent activity and defended the trust and, after his father’s death, the will.

Soon after J. Howard died, in January 1996, Vickie filed a petition for bankruptcy in the United States District Court for the Central District of California. In June 1996, Pierce filed a proof of claim in the federal bankruptcy proceeding, alleging that Vickie had defamed him when attorneys representing Vickie told members of the press that Pierce had engaged in forgery, fraud, and overreaching to gain control of his father's assets. Vickie answered, asserting truth as a defense. She also filed counterclaims, among them a claim that Pierce had tortiously interfered with a gift she expected. She contended that Pierce essentially imprisoned J. Howard against his wishes; surrounded him with hired guards for the purpose of preventing contact with Vickie; made misrepresentations to J. Howard; and transferred property against J. Howard's expressed wishes.

The Bankruptcy Court granted summary judgment in favor of Vickie on Pierce’s claim and, after a trial on the merits, entered judgment for Vickie on her tortious interference counterclaim. The court awarded Vickie compensatory damages of more than $449 million—less whatever she recovered in the ongoing probate action in Texas—as well as $25 million in punitive damages.

The District Court concluded that the Bankruptcy Court lacked the authority to issue a final judgment on Vickie’s counterclaim and thus said that it would treat the Bankruptcy Court’s judgment as “proposed rather than final” and engaged in an “independent review of the record.”

However, subsequent to the Bankruptcy Court decision, but prior to the decision of the District Court, the Texas Probate Court had conducted a jury trial and ruled in favor of Pierce. The District Court, however, did not give preclusive effect to this decision and agreed with the Bankruptcy Court that Pierce had tortiously interfered with Vickie’s inheritance. The District Court reduced the damages to approximately $88 million, divided equally between compensatory and punitive damages.

The issue before the Supreme Court concerned preclusion. If the Bankruptcy Court had the authority to issue a final judgment, then its ruling was preclusive of the Texas probate court’s decision, and Vickie’s estate wins. But if the Bankruptcy Court lacked the authority to issue a final judgment, then there was no preclusion of the Texas probate court, and Pierce’s estate wins.

The Court, 5-4, took the latter approach. The Court said that the Bankruptcy Act in § 157(b)(2)(c) expressly makes counterclaims “core” proceedings over which the bankruptcy court could issue a final judgment. But the Court found that this violated the Constitution because bankruptcy judges do not have life tenure. Chief Justice Roberts’ majority opinion began by stressing the essential nature of Article III protections for separation of powers and the protection of individual liberties.

The underlying rationale for this seems dubious. The Court’s emphasis on the importance of an independent judiciary would make sense if this were an issue of federal constitutional law, especially one where life tenure might make judges more inclined to withstand popular pressure and uphold the Constitution. But the issue in Stern v. Marshall was a state law claim that by itself would not even fit within the scope of the matters which federal courts are allowed to hear under Article III, section 2 of the Constitution. State law claims are generally adjudicated by state law judges who rarely have life tenure. What then was so objectionable about Congress authorizing bankruptcy judges without life tenure to hear the matters?

Two questions are key after Stern v. Marshall. First, what are the areas where bankruptcy courts cannot issue final judgments? Chief Justice Roberts concluded the majority opinion by painting it as a narrow holding and declaring: “We conclude today that Congress, in one isolated respect, exceeded [the limitation of Article III] in the Bankruptcy Act of 1984.” But if this provision of the Bankruptcy Act is unconstitutional, then what other provisions are similarly impermissible in giving bankruptcy courts authority to issue final judgments? Bankruptcy courts constantly decide state law questions; after Stern v. Marshall when can they issue final judgments on these matters?

In what is likely the most important language of the opinion in terms of when bankruptcy courts can issue final judgments, the Court said that “the question is whether the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” This, though, significantly limits the ability of bankruptcy courts to issue final judgments. For example, several courts have now ruled that bankruptcy courts cannot issue final judgments on an action to avoid a fraudulent conveyance, and the Ninth Circuit has asked for briefing on that issue.

Second, the crucial practical question will be whether consent can cure this and whether bankruptcy courts can issue final judgments with consent of the parties. If so, the effect of Stern v. Marshall will be greatly reduced; if not, the implications of Stern v. Marshall are enormous and transcend the bankruptcy context, including whether magistrate judges can continue to hold civil trials with consent of the parties.

On the one hand, no principle of federal jurisdiction is more clearly established than that a limit on the power of a federal court cannot be overcome by consent. On the other hand, some bankruptcy courts since Stern v. Marshall have held that there is a distinction between the subject matter jurisdiction of a bankruptcy court and its power to issue final judgments; consent cannot cure a defect in the former, but it can allow for the latter.

Ultimately, this question, like so many raised by Stern v. Marshall, must wait for further clarification by the Supreme Court.

*Erwin Chemerinsky, Dean and Distinguished Professor of Law, University of California, Irvine School of Law.