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Bankruptcy Court Jurisdiction Raises Constitutional Questions With Economic Consequences

September 01, 2015, 07:00 AM

We all learned about the system of checks and balances in the U.S. Constitution in high school civics classes. Our government is set up with interlocking rights, duties, and powers between and among the President as the senior representative of the Executive Branch, the Legislative Branch (the House of Representatives and Senate in Congress), and the Judicial Branch. The federal judiciary contains a labyrinth of courts, including the very significant bankruptcy courts that handled cases like Chrysler, GM, Lehman Brothers, and the City of Detroit, and that have recently sent shock waves into the banking community with adverse rulings on the validity of prepayment premiums, among other things.

Where do bankruptcy courts fit under our system of checks and balances? We know that (1) the President appoints judges under Articles II and III of the Constitution; (2) with the advice and consent of the Senate (but not the House); (3) the judges receive life tenure and protection from salary diminution; (4) but the judges can be removed, as can other officers, (5) for treason, bribery, or other high crimes and misdemeanors, (6) through impeachment on claims brought by the House and (7) conviction by the Senate.

The system of checks and balances, and separation of powers, has found a practical manifestation in a series of decisions of the Supreme Court that address the judicial authority of bankruptcy judges. Bankruptcy judges do not have life tenure and protection from salary diminution under Article III of the U.S. Constitution.In addition they are appointed by the Courts of Appeal and not the President with Senate approval.  How does this absence of Article III compliance impact what bankruptcy judges are allowed to do and how does it affect your economic interests?  The answer to the first question is presented in the Supreme Court’s recent trilogy of decisions in Stern v. Marshall (aka Anna Nicole Smith), Arkison, and Wellness, which essentially held that the bankruptcy court can’t make final decisions in many cases without consent of the parties.

In a recent decision in the Nortel bankruptcy case, the bankruptcy court noted that allocation of $7.3 billion between various international bankruptcy estates was likely going to be materially slowed due to delays in the case because parties in that litigation had not consented to the bankruptcy court issuing final orders ruling on the pending claims for copyright infringement, misappropriation of trade secrets, and breach of contract. What is the problem?  Why didn’t they consent in Nortel? Bankruptcy judges are almost always commercially sophisticated, practical, and prompt. In Nortel, why did the parties also request a jury trial and file in a bankruptcy court that cannot conduct jury trials? The answer to this and thus to the second question may be found in a case like Tousa in which the punchline – so to speak – was that if the losing lenders had challenged the ability of the bankruptcy court to issue final orders, and thus required that the bankruptcy judge issue proposed findings and recommendations, those would have been subject to de novo review by a district court.  If there had been de novo review, which essentially is a fresh look at the evidence by the district court judge, and even the ability to accept new evidence, the defendant lenders in Tousa would not have faced a judgment avoiding transfers aggregating about $920 million.

The moral of the story is that if you have cancer, see an oncologist; if you have heart disease, see a cardiologist; and if you are in bankruptcy court, talk to a commercially sophisticated and experienced bankruptcy litigator from the start to be sure you make the hard strategic decisions you have to from the very beginning.  If you don’t, you may be on the wrong side of an unfortunate negative $920 million result where hindsight is always 20-20.

Grant T. Stein
Senior Partner | Alston & Bird LLP
Grant T. Stein is a senior partner in Alston & Bird LLP’s Bankruptcy & Financial Restructuring Group in Atlanta.
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