Challenge to Constitutional Authority of Bankruptcy Court to Enter a Final Judgment on a State-Law Claim under Stern v. Marshall under Article III § 1 Is Not Waivable — Circuit Split
Wellness Int’l Network, Ltd. v. Sharif, 2013 U.S. App. LEXIS 17553 (7th Cir. Aug. 21, 2013):
This appeal is the most recent chapter in a decade-long saga spanning two circuits involving the debtor, Richard Sharif, and his judgment creditors, Wellness International Network, Ltd., Ralph Oats, and Cathy Oats (collectively, "WIN"). After being slapped with a judgment in excess of $650,000 in the Northern District of Texas as a sanction for his failure to engage in discovery, Sharif filed for Chapter 7 bankruptcy in the Northern District of Illinois. WIN filed a five-count adversary complaint in the bankruptcy court. Counts I through IV sought to prevent discharge of Sharif's debts under 11 U.S.C. § 727, and Count V sought a declaratory judgment that a trust [*2] of which Sharif was trustee was in fact Sharif's alter ego. Sharif continued his evasive and dilatory tactics, failing to respond to WIN's and the bankruptcy trustee's discovery requests. The bankruptcy court ordered Sharif to comply with the discovery requests and warned him that failure to do so would result in a default judgment. Sharif tendered some discovery but his responses fell far short of full compliance. After a hearing, the bankruptcy judge issued an opinion and order entering default judgment in WIN's favor and subsequently awarded attorney's fees to WIN. Sharif appealed to the district court. See 28 U.S.C. § 158(a)(1).
After the bankruptcy judge's entry of judgment but before briefing on the appeal in the district court, the Supreme Court decided Stern v. Marshall, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011), in which it held that a bankruptcy court lacked constitutional authority to enter final judgment on a debtor's state-law counterclaim against a creditor, even though Congress had granted the bankruptcy court statutory authority to do so. A few months after Stern was decided, Sharif filed his opening brief in the district court, but he did not challenge the bankruptcy judge's authority to enter final judgment on the adversary complaint. In December 2011, Sharif's sister filed a motion in the district court to withdraw the reference on the basis of Stern. Later that month, our court decided Ortiz v. Aurora Health Care, Inc. (In re Ortiz), 665 F.3d 906 (7th Cir. 2011), in which we dismissed a direct appeal from a bankruptcy court on the ground that there was no final judgment because the bankruptcy judge had lacked constitutional authority to enter one under Stern. Shortly thereafter, Sharif filed a motion for supplemental briefing in the district court so that he could advance a Stern argument. The district judge denied both motions as untimely, holding that a Stern objection to a bankruptcy judge's authority to enter final judgment is waivable and that Sharif's failure to raise it earlier constituted waiver, and affirmed the bankruptcy court's entry of default judgment. Sharif's sister did not appeal the denial of her motion to withdraw the reference, but Sharif appealed the balance of the district court's decision to this court.
We hold that a constitutional objection based on Stern is not waivable because it implicates separation-of-powers principles. We also hold that the bankruptcy judge lacked constitutional authority to enter a final judgment on the alter-ego claim. In contrast, we hold that the bankruptcy judge had constitutional authority to enter final judgment on the first four counts of the adversary complaint, each of which were objections to the discharge of Sharif's debts. Finally, we hold that the entry of default judgment and awarding of fees were proper sanctions under the circumstances, though we remand for a recalculation of fees.
WIN asserts, and the district court held, that Stern itself indicates that Sharif's Article III objection is waivable and that, through his litigation conduct and failure to raise the objection sooner, Sharif in fact waived it. See Sharifeh, 2012 U.S. Dist. LEXIS 17478, 2012 WL 469980, at *10; see also 2012 U.S. Dist. LEXIS 17478, [Wl] at *5-7 (denying Ragda's motion to withdraw the reference on the ground that she had waived her Stern objection). Sharif, on the other hand, contends that his Stern objection is not waivable and can be raised at any time because it concerns the bankruptcy court's subject-matter jurisdiction. Neither view is persuasive.
In Stern, the Court held that Pierce had waived his alternative, nonconstitutional argument that the bankruptcy court had lacked jurisdiction over his defamation claim under 28 U.S.C. § 157(b)(5) ("personal injury tort and wrongful death claims shall be tried in the district court"). 131 S. Ct. at 2606-08. The Court reasoned that neither the text nor the context of § 157(b)(5) had the hallmarks of a jurisdictional statute and explained that "we are not inclined to interpret statutes as creating a jurisdictional bar when they are not framed as such." Id. at 2607 (citing Arbaugh v. Y & H Corp., 546 U.S. 500, 516, 126 S. Ct. 1235, 163 L. Ed. 2d 1097 (2006)). Section 157 in general merely "allocates the authority to enter final judgment between the bankruptcy court and the district court" and "does not implicate questions of subject-matter jurisdiction." Id. (citations omitted). And § 157(b)(5) merely "specifies where a particular category of cases should be tried." Id. The Court held that these "statutory limitation[s]" were waivable and that, given his "course of conduct" in the bankruptcy court, Pierce had "consented to that court's resolution of his defamation claim (and [had] forfeited any argument to the contrary)." Id. at 2607-08.
At first blush, then, Stern appears to support WIN's waiver argument. But there is a significant difference between the waived objection in Stern and Sharif's objection, namely, the argument in Stern concerned only the bankruptcy court's statutory authority, whereas Sharif's argument concerns the bankruptcy court's constitutional authority. We discern nothing in Stern that supports the proposition that a party may waive an Article III objection to a bankruptcy judge's entry of final judgment. In point of fact, a different portion of the Stern opinion casts serious doubt on whether notions of waiver and consent have any role in bankruptcy, given that creditors must go to the bankruptcy court to pursue their claims. See 131 S. Ct. at 2614-15 & n.8; see also Granfinanciera, 492 U.S. at 59 n.14. For these reasons, we do not think Stern supports WIN's position.
As for Sharif's argument, it is true that questions of subject-matter jurisdiction may be raised at any time, as parties cannot consent to subject-matter jurisdiction; indeed, such questions must be considered by a court sua sponte. See, e.g., Steel Co. v. Citizens for a Better Env't, 523 U.S. 83, 94-95, 118 S. Ct. 1003, 140 L. Ed. 2d 210 (1998); Capron v. Van Noorden, 6 U.S. (2 Cranch) 126, 127, 2 L. Ed. 229 (1804). But we disagree with Sharif that his Article III, § 1, objection concerns the bankruptcy court's subject-matter jurisdiction, for several reasons. First, as noted above, Stern held that § 157 constitutes a statutory allocation of authority between the bankruptcy courts and the district courts, and Article III, § 1, can be viewed similarly, that is, as an allocation of authority between Article III courts and non-Article III courts. Second, in resolving the constitutional issue in Stern, the Court never asserted that the bankruptcy court in that case had lacked subject-matter jurisdiction; rather, it held that "[t]he Bankruptcy Court ... lacked the constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof of claim," 131 S. Ct. at 2620 (emphasis added). Third, the constitutional bases of federal subject-matter jurisdiction are set forth in Article III, § 2, whereas Sharif's objection to the bankruptcy court's entry of final judgment is based on Article III, § 1. Finally, Sharif's reliance on Ortiz for the proposition that a Stern objection is jurisdictional is misplaced, as the jurisdictional issue in Ortiz concerned whether there was a valid final judgment for purposes of appellate jurisdiction, given the unique procedural posture of that appeal (a direct appeal from the bankruptcy court); Ortiz did not hold that the bankruptcy court had lacked jurisdiction. Consequently, we do not think the waiver issue can be resolved under the well-established principle that questions of subject-matter jurisdiction are not waivable. Nevertheless, we agree with Sharif that under current law his constitutional objection to the bankruptcy court's entry of final judgment is not waivable.
Although consent has no role under Article III, § 2, the Supreme Court has acknowledged a limited role for notions of consent and waiver under Article III, § 1. See Stern, 131 S. Ct. at 2613-14; id. at 2625-26, 2627-28 (Breyer, J., dissenting); Peretz v. United States, 501 U.S. 923, 936-39, 111 S. Ct. 2661, 115 L. Ed. 2d 808 (1991); Granfinanciera, 492 U.S. at 59 n.14; Commodity Futures Trading Comm'n v. Schor, 478 U.S. 833, 848-57, 106 S. Ct. 3245, 92 L. Ed. 2d 675 (1986); cf. Roell v. Withrow, 538 U.S. 580, 123 S. Ct. 1696, 155 L. Ed. 2d 775 (2003) (holding that under 28 U.S.C. § 636(c)(1) parties may consent to proceedings before a magistrate judge through their litigation conduct).
This appears to stem from the fact that § 1 protects two separate interests--it safeguards litigants' right to have their cases decided by independent and impartial judges, and it also operates as an inseparable element of separation of powers by protecting the judicial branch from encroachment by the political branches. Stern, 131 S. Ct. at 2608-09; Schor, 478 U.S. at 848-50; N. Pipeline, 458 U.S. at 58 (plurality opinion). The guarantee of an independent and impartial judiciary serves primarily to protect personal interests, and so it "is subject to waiver, just as are other personal constitutional rights that dictate the procedures by which civil and criminal matters must be tried." Schor, 478 U.S. at 848-49 (citations omitted). The role that § 1 plays in our system of checks and balances, however, protects the larger structural interests of our constitutional government, and "[t]o the extent that this structural principle is implicated in a given case, the parties cannot by consent cure the constitutional difficulty for the same reason that the parties by consent cannot confer on federal courts subject-matter jurisdiction beyond the limitations imposed by Article III, § 2." Id. at 850-51 (citation omitted). "When these Article III limitations are at issue, notions of consent and waiver cannot be dispositive because the limitations serve institutional interests that the parties cannot be expected to protect." Id. at 851; see also Freytag v. C.I.R., 501 U.S. 868, 896-98, 111 S. Ct. 2631, 115 L. Ed. 2d 764 (1991) (Scalia, J., concurring in judgment). But cf. Plaut v. Spendthrift Farm, Inc., 514 U.S. 211, 231, 115 S. Ct. 1447, 131 L. Ed. 2d 328 (1995) (rejecting proposition "that legal defenses based upon doctrines central to the courts' structural independence can never be waived"); Freytag, 501 U.S. at 893-901 (same).
The dual nature of Article III, § 1, renders notions of waiver and consent more nuanced than they are in other areas. The practical problem, of course, is the difficulty of separating out the waivable personal safeguard from the nonwaivable structural safeguard, for in every case an argument that a party waived the personal protection can be met with the argument that the court must still consider the objection because the structural aspect cannot be waived. The net result would be that an Article III, § 1, argument can never be waived and that parties can never consent to adjudication by a non-Article III tribunal, which would render Schor's discussion of the waivability of the personal protections meaningless. But a close examination of Schor demonstrates how this difficulty is to be resolved.
Schor involved an Article III challenge to an agency's authority to decide a state-law counterclaim. A customer brought a claim for reparations against his commodity futures broker before the Commodity Futures Trading Commission (CFTC), and the broker filed a state-law counterclaim for the same amount. After the CFTC ruled in favor of the broker on both the claim and the counterclaim, the customer appealed on the ground that the CFTC's adjudication of the counterclaim ran afoul of Article III, § 1. The Court held that the CFTC's assumption of jurisdiction over the state-law counterclaim was not unconstitutional. Although the customer had consented to proceed before the CFTC rather than an Article III court, id. at 849-50, the Court explained that consent could not be dispositive due to the structural interests protected by Article III, § 1, id. at 851. The Court then examined several factors and held that "the congressional scheme [did] not impermissibly intrude on the province of the judiciary." Id. at 851-52. While the counterclaim at issue was a private right (rather than a public right) traditionally decided by courts, the Court found it significant that the CFTC dealt only with a "'particularized area of law,'" id. at 852 (quoting N. Pipeline, 458 U.S. at 85 (plurality opinion)); the CFTC's adjudicatory powers departed from the traditional agency model in only one respect, its jurisdiction over state-law counterclaims, id.; like in Crowell, 285 U.S. 22, 52 S. Ct. 285, 76 L. Ed. 598, the CFTC's orders were enforceable only by a district court, its factual findings were reviewed under a "weight of the evidence" standard, and its legal conclusions were reviewed de novo, Schor, 478 U.S. at 853; and the CFTC's counterclaim jurisdiction was "limited to that which [was] necessary to make the reparations procedure workable," id. at 856. Therefore, the Court concluded, "the magnitude of any intrusion on the Judicial Branch [could] only be termed de minimis." Id.; see also Peretz, 501 U.S. at 936-37 (holding that a criminal defendant in a felony trial may consent to jury selection presided over by a magistrate judge: no structural issues were implicated because magistrates were appointed and subject to removal by Article III judges; the district court made the ultimate decision to invoke the magistrate's assistance, subject to veto by the parties; and the decision whether to empanel the jury whose selection was overseen by the magistrate remained entirely with the trial judge).
As noted earlier, since we heard oral argument, two of our sister circuits have addressed the waiver issue head-on and have come to divergent conclusions; both circuits relied on Schor. In Waldman v. Stone, the Sixth Circuit held that a Stern objection to the bankruptcy court's constitutional authority is not waivable. 698 F.3d at 917-18. Stone filed for bankruptcy and initiated an adversary proceeding against Waldman, seeking both discharge of his debts to Waldman and affirmative relief (e.g., fraud, specific performance). After a bench trial, the bankruptcy court discharged Stone's obligations and awarded him a little over $3 million on his affirmative claims. Id. at 915-16. On appeal, the court held that Waldman could and had in fact waived any objection to the bankruptcy court's statutory authority, but it held that Waldman could not waive the constitutional objection. Id. at 917-18. The court rejected the argument that, in bankruptcy cases like Stone's, the "personal right" character predominates. Id. While acknowledging that the case did not pose a great risk of aggrandizement of the legislative and executive branches, the court explained that this took "too narrow a view of the interests preserved by Article III," which is also concerned with diminution of the judicial branch. Id. at 918; see also id. ("To the extent that Congress can shift the judicial Power to judges without [the tenure and salary] protections, the Judicial Branch is weaker and less independent than it is supposed to be." (citing Schor, 478 U.S. at 850)). And because Waldman's objection implicated both his personal rights and the structural interests advanced by Article III, the objection could not be waived. Id.
The Ninth Circuit reached the opposite conclusion in In re Bellingham Insurance Agency, Inc., 702 F.3d at 566-70. In that case, Bellingham Insurance Agency, Inc., filed a Chapter 7 bankruptcy petition, after which the trustee filed a complaint against Executive Benefits Insurance Agency, Inc., seeking to recover allegedly fraudulent conveyances and to hold Executive Benefits liable for Bellingham's debts. The bankruptcy court granted summary judgment to the trustee, and the district court affirmed. Prior to oral argument before the Ninth Circuit, Executive Benefits argued for the first time that the bankruptcy judge was constitutionally prohibited from entering final judgment on the trustee's claims. Id. at 557. The court held that Executive Benefits had waived its right to have an Article III judge decide the matter, see id. at 566-70, finding the waivable nature of an Article III, § 1, objection to be "well established," id. at 566-67 (citing MacDonald v. Plymouth Cnty. Trust Co., 286 U.S. 263, 267, 52 S. Ct. 505, 76 L. Ed. 1093 (1932)). Like the Sixth Circuit it relied on Schor: "Following the genesis of the modern bankruptcy system, the Supreme Court clarified that 'Article III, § 1's guarantee of an independent and impartial adjudication by the federal judiciary of matters within the judicial power of the United States ... serves to protect primarily personal, rather than structural, interests.'" Id. at 567 (quoting Schor, 478 U.S. at 848). In a footnote, the court acknowledged that Schor held "that 'notions of consent and waiver cannot be dispositive' of Article III problems when 'the encroachment or aggrandizement of one branch at the expense of the other' is at stake, because in such cases structural principles are implicated in addition to private rights entitlements." Id. at 567 n.9 (quoting Schor, 478 U.S. at 850-51). But it reasoned that while aggrandizement was an issue in Schor (because that case involved an executive agency adjudicating a state-law counterclaim), "the allocation of authority between bankruptcy courts and district courts does not implicate structural interests, because bankruptcy judges are 'officer[s] of' the district court and are appointed by the Courts of Appeals." Id. (emphasis added) (citing 28 U.S.C. §§ 151, 152(a)(1)). Therefore, the court concluded, "'as a personal right, Article III's guarantee of an impartial and independent federal adjudication is subject to waiver.'" Id. at 567 (quoting Schor, 478 U.S. at 848). In another footnote, the court commented that it is this principle that allows "federal magistrate judges, acting with the consent of the litigants, to enter final judgments in proceedings that would otherwise be the exclusive province of Article III courts." Id. at 567 n.10 (citing 28 U.S.C. § 636(c)(1)). It also noted that consent to a magistrate's entry of final judgment "may be implied from a litigant's actions." Id. (citing Roell, 538 U.S. at 586-87). Finally, the court observed that "§ 157(c)(2) expressly provides that bankruptcy courts may enter final judgments in non-core proceedings 'with the consent of all the parties to the proceeding,'" id. at 567, and it concluded that "[i]f consent permits a non-Article III judge to decide finally a non-core proceeding, then it surely permits the same judge to decide a core proceeding in which he would, absent consent, be disentitled to enter final judgment," id.
We think the Sixth Circuit has the better view under current law. Schor holds that waiver or consent may be a factor in determining whether delegation of judicial business to non-Article III tribunals is unconstitutional, but it cannot be dispositive because of the structural role of Article III, § 1. And Stern unequivocally holds that 28 U.S.C. § 157(b) violates the structural protections of Article III, § 1, in permitting a bankruptcy judge to enter final judgment in certain "core proceedings." In other words, unlike Schor, where party consent was permissible because the statutory scheme at issue did not implicate structural concerns, the Supreme Court has already held that the statutory scheme granting bankruptcy judges authority to enter final judgment in core proceedings does implicate structural concerns where the core proceeding at issue is "'the stuff of the traditional actions at common law tried by the courts at Westminster in 1789,'" Stern, 131 S. Ct. at 2609 (quoting N. Pipeline, 458 U.S. at 90 (Rehnquist, J., concurring in judgment)). Therefore, we cannot agree with our colleagues on the Ninth Circuit that the allocation of authority between bankruptcy courts and district courts with regard to core proceedings does not implicate structural interests. We also observe that in Stern the Court rejected the proposition that the fact that bankruptcy judges are appointed by Article III judges makes a difference; the Court explained that since it was the bankruptcy court itself that "exercise[d] 'the essential attributes of judicial power [that] are reserved to Article III courts,' it [did] not matter who appointed the bankruptcy judge or authorized the judge to render final judgments in such [*53] proceedings. The constitutional bar remain[ed]." Id. at 2619 (second alteration in original) (quoting Schor, 478 U.S. at 851).
It is true that under 28 U.S.C. § 157(c)(2) parties may consent to final resolution of a noncore proceeding by a bankruptcy judge, but we do not think that this inexorably leads to the conclusion that parties may consent to final adjudication of a core proceeding by a bankruptcy judge or waive a Stern objection. For one thing, the Supreme Court has not passed on the constitutionality of § 157(c). Cf. Stern, 131 S. Ct. at 2615 n.8 (observing that "the notion of 'consent' does not apply in bankruptcy proceedings as it might in other contexts"); Granfinanciera, 492 U.S. at 59 n.14 ("Parallel reasoning [to Schor] is unavailable in the context of bankruptcy proceedings, because creditors lack an alternative forum to the bankruptcy court in which to pursue their claims."). In any event, the statutory scheme established by Congress for core proceedings differs in significant respects from the scheme for noncore proceedings. Whereas Congress has vested bankruptcy judges with authority to enter final orders and judgments in core proceedings subject only to review by the district court under traditional appellate standards, see §§ 157(b), 158(a), in noncore proceedings Congress has vested bankruptcy judges with authority to hear the matter and submit proposed findings of fact and conclusions of law to the district court, and it is the district court that enters final judgment after de novo review, § 157(c)(1). Section 157(c)(2) permits a bankruptcy judge to enter final judgment in a noncore proceeding, but only if the parties consent and the district court decides to refer the matter to the bankruptcy court. Thus, a strong argument can be made that with respect to noncore proceedings Congress has left the essential attributes of judicial power to Article III courts, and so the structural interests at issue with regard to core proceedings are not present under the current statutory scheme applicable to noncore proceedings, thereby allowing room for notions of waiver and consent. Cf. Peretz, 501 U.S. at 936-37; United States v. Raddatz, 447 U.S. 667, 681-84, 100 S. Ct. 2406, 65 L. Ed. 2d 424 (1980) (holding that there was no Article III impediment to a magistrate judge's submission of proposed findings of fact and conclusions of law concerning suppression motion because ultimate suppression decision was made by the district judge). In this case we need not, and do not, express an opinion on the constitutionality of § 157(c)(2), or for that matter § 636(c)(1), which permits litigants to consent to entry of final judgment by a magistrate judge, cf. Technical Automation Servs. Corp. v. Liberty Surplus Ins. Corp., 673 F.3d 399, 404-07 (5th Cir. 2012) (declining to hold that Stern affected a magistrate judge's authority to enter final judgment on a state-law counterclaim under § 636(c)(1)). Our discussion is intended only to show that, unlike the Ninth Circuit, we do not think that a party's Stern objection to a bankruptcy court's entry of final judgment in a core proceeding is waivable simply because Congress has authorized litigants to consent to a bankruptcy judge's final adjudication of a noncore proceeding.
In sum, we hold that under current law a litigant may not waive an Article III, § 1, objection to a bankruptcy court's entry of final judgment in a core proceeding.
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