Business Law

Leib Lerner’s e-Bulletin re the upcoming Supreme Court decisions in Executive Benefits Ins. Agency v. Arkison and Law v. Siegel.

Dear constituency list members of the Insolvency Law Committee, the following is a case update on two cases of interest that will be heard by the United States Supreme Court:

SUMMARY

This January, the United States Supreme Court will hear oral arguments on two bankruptcy cases originating out of the Ninth Circuit Court of Appeals:  Law v. Siegel, No. 12-5196 and Executive Benefits Ins. Agency v. Arkison, No. 12-1200. 

The cases present distinct questions.  In Law, the question is whether—pursuant either to its authority under 11 U.S.C. § 105(a) or to its inherent power to sanction misconduct—a bankruptcy court may impose an equitable surcharge on a debtor’s residential property, protected by the homestead exemption, in order to compensate the estate for litigation costs that it incurred as a result of the debtor’s bad-faith litigation conduct.  In Executive Benefits Ins. Agency, the questions are: (i) whether, in light of Stern v. Marshall, 131 S. Ct. 2594 (2011), bankruptcy courts have the constitutional authority to enter a final judgment in a fraudulent conveyance action against a non-creditor, (ii) whether parties may consent to final judgment by a bankruptcy court, and whether litigation conduct reflecting an implied consent to the entry of final judgment by a bankruptcy judge may waive the right to have certain fraudulent-conveyance claims adjudicated only by an Article III court, and (iii) whether a bankruptcy judge has the statutory authority to issue proposed findings of fact and conclusions of law, subject to a district court’s de novo review, regarding a fraudulent-conveyance claim filed by the estate against a non-creditor

FACTUAL AND PROCEDURAL BACKGROUND: LAW V. SIEGEL (IN RE LAW)

Stephen Law filed a chapter 7 petition and claimed a $75,000 homestead exemption, pursuant to 11 U.S.C. § 522 and California law, with respect to a residence in Hacienda Heights, California.  He further scheduled two voluntary liens on the residence, one of which was a second deed of trust supported by a purported $168,000 personal loan from a woman named Lili Lin.  The chapter 7 trustee, Alfred Siegel, instituted an adversary proceeding to avoid the Lin lien as a fraudulent transfer, and obtained a default judgment avoiding the lien.  The default judgment was vacated after a Lili Lin of China filed a motion to set aside the judgment through her attorney.  After the judgment was vacated, a Lili Lin of Artesia, California, responded and executed a stipulation for judgment purporting to resolve the adversary proceeding.  In the stipulated judgment, Lili Lin of Artesia acknowledged (1) that she had never made a loan to the debtor and (2) that that the debtor had attempted to involve her in a sham foreclosure of the disputed deed of trust.

The trustee filed a motion to surcharge Debtor’s homestead exemption, to cover the trustee’s litigation costs and expenses, and moved to sell the Property.  The trustee argued that the surcharge was warranted due to the debtor’s “exceptional circumstances of misconduct” by “willfully and knowingly attempt[ing] to defraud his creditors by removing equity from the property.”  The bankruptcy court granted the motion, ruling that the debtor’s litigiousness had been a direct cause of the trustee’s increased fees and expenses, and that an equitable surcharge was authorized by 11 U.S.C. § 105(a).  On appeal, the surcharge motion was reversed by the Bankruptcy Appellate Panel and the reversal was affirmed by the Ninth Circuit, on the grounds that a surcharge could not be used to punish the debtor. 

When presented with the trustee’s renewed motion to surcharge the debtor’s homestead exemption, the bankruptcy court found the surcharge was appropriate to compensate for the debtor’s misconduct and prevent fraud caused by misconduct.  The debtor appealed this decision to the Ninth Circuit Bankruptcy Appellate Panel, which this time affirmed the bankruptcy court’s imposition of a surcharge.  The Ninth Circuit Court of Appeals affirmed.  The Supreme Court granted certiorari.  Briefing is complete, and oral argument is scheduled for January 13, 2014. 

AUTHORS’ COMMENTARY

The dispute boils down to whether or not the specific provisions of section 522 prevent the bankruptcy court from using its general equitable powers under section 105 to surcharge a debtor’s exemption.  Amicus briefs in support of the debtor have been filed by the National Association of Consumer Bankruptcy Attorneys and by various law scholars.  The National Association of Bankruptcy Trustees, the National Association of Chapter Thirteen Trustees and the United States filed briefs in support of the trustee.  The Supreme Court’s decision can be expected to resolve the split between the first and ninth circuits and the tenth circuit.  Compare Malley v. Agin, 693 F.3d 28, 30 (1st Cir. 2012) and Latman v. Burdette, 366 F.3d 774, 785 & n.8 (9th Cir. 2004) (permitting surcharge), with In Re Scrivner, 535 F.3d 1258 (10th Cir.2008) (not permitting surcharge).

FACTUAL AND PROCEDURAL BACKGROUND: EXECUTIVE BENEFITS INS. AGENCY V. ARKISON (IN RE BELLINGHAM INS. AGENCY, INC.)

Debtor Bellingham Insurance Agency, Inc.’s chapter 7 trustee initiated an adversary proceeding against a non-creditor, Executive Benefits Insurance Agency (“EBIA”), seeking to, among other things, avoid and recover an allegedly fraudulent conveyance to EBIA, under section 548 of the Bankruptcy Code.

The bankruptcy court ultimately granted summary judgment in favor of the trustee (finding the transfers to be fraudulent) and entered a final judgment in favor of the trustee for $373,291.28.  EBIA appealed to the district court, which affirmed the summary judgment.  EBIA then appealed to the Ninth Circuit Court of Appeals.

In a motion to dismiss submitted prior to oral argument, EBIA objected for the first time to the bankruptcy judge’s entry of final judgment on the trustee’s fraudulent conveyance claims—relying on the landmark Supreme Court case Stern v. Marshall—and claiming the bankruptcy court did not have the constitutional authority to enter final judgment on the fraudulent conveyance claims.  The Ninth Circuit held that, following Stern v. Marshall, while the bankruptcy court had the statutory authority to hear and determine a fraudulent conveyance claim against a non-creditor, the bankruptcy court lacked the constitutional authority to enter final judgment.  The next issue analyzed by the Ninth Circuit is whether bankruptcy courts may still enter proposed findings of fact and conclusions of law pursuant to 28 U.S.C. § 157(c)(1) given that fraudulent conveyance claims are “core” claims based on 28 U.S.C. § 157(b)(2)(H), but notwithstanding 28 U.S.C. § 157(b)(1), bankruptcy courts lack the constitutional authority to enter final judgment against non-creditors.  The Ninth Circuit held that bankruptcy courts may still enter proposed findings of fact and conclusions of law, reasoning that fraudulent conveyance claims remain in the “core,” and that only the power to enter a final judgment against non-creditors is abrogated.  The Ninth Circuit ultimately decided against EBIA, holding that parties may waivetheir right to an Article III court, and that EBIA waived its right because it failed to timely object to the bankruptcy court’s exercise of jurisdiction over the fraudulent conveyance claim.

The Supreme Court granted EBIA’s petition for certiorari.  Briefing is complete and oral argument is scheduled for January 14, 2014.

AUTHORS’ COMMENTARY

The Supreme Court’s upcoming decision is expected to resolve a circuit split regarding whether the right to an Article III tribunal, identified by Stern, is waivable by litigant consent.  See Waldman v. Stone, 698 F.3d 910 (6th Cir. 2012) and Wellness Int’l Network Ltd. v. Sharif, __ F.3d __, No. 12-1349, 2013 WL 4441926, at *17-18 (7th Cir. Aug. 21, 2013) (holding the right is not subject to waiver).  Previous E-Bulletins have discussed the merits of both positions.  Compare Dan Schechter, Bankruptcy E-Bulletin (Dec. 10, 2012) (arguing that the issue is one of subject matter jurisdiction, which cannot be waived by the parties), with Adam Lewis, Bankruptcy E-Bulletin (Jan. 9, 2013) (arguing the contrary).  The Supreme Court’s decision is hotly anticipated, because a determination that consent cannot cure the constitutional issues identified by Stern could shift numerous cases from bankruptcy courts to district courts.  The Supreme Court will also have the opportunity to resolve the split, between Bellingham and Wellness, regarding whether a bankruptcy court has statutory authority under section 157 to issue proposed findings of fact and conclusions of law in core matters to a federal district court. 

For more information on both of the cases discussed above, the American Bar Association has a helpful website with links to the merit briefs by the parties and amici curie, available at http://www.americanbar.org/publications/preview_home/alphabetical.htm.

These materials were prepared by Leib M. Lerner, a partner at Alston & Bird LLP in Los Angeles, California (leib.lerner@alston.com) and John Spears, an associate at Alston & Bird LLP in New York, New York (john.spears@alston.com).  Mr. Lerner is a member of the Insolvency Law Committee.  Editorial contributions were provided by Insolvency Law Committee member Ori Katz (OKatz@sheppardmullin.com) of Sheppard Mullin in San Francisco, California.Thank you for your continued support of the Committee.

Best regards,

Insolvency Law Committee

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