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Bankruptcy Court Finds Its Authority to Determine Claim Unaffected By Supreme Court's Stern v. Marshall Decision

Wednesday, January 4, 2012
McClelland v. Grubb & Ellis Valuation and Advisory Group (In re McClelland), No. 03-37997, Adv. Pro. No. 07-9014, 2011 BL 312440 (Bankr. S.D.N.Y. Dec. 9, 2011)
  • Finding that the Stern v. Marshall decision only partially invalidated 28 U.S.C. § 157(b)(2)(C), leaving the other examples of “core” proceedings contained in § 157(b)(2) unaffected.
The United States Bankruptcy Court for the Southern District of New York held that a state-law adversary proceeding filed by a debtor-plaintiff against an estate-appointed professional for gross negligence was a "core" proceeding pursuant to 28 U.S.C. § 157(b)(2)(A), finding that it concerned the administration of the estate as it involved work performed on behalf of the estate by professionals appointed and approved by the court and compensated by the estate. In so ruling, the bankruptcy court rejected the debtor-plaintiff's argument that the claim was a counterclaim within the scope of 28 U.S.C. § 157(b)(2)(C), the provision that the Supreme Court found unconstitutional in Stern v. Marshall, 131 S.Ct. 2594 (2011).

The Adversary Proceeding and Removal Motion

In 2003, John McClelland (“Plaintiff”) filed for bankruptcy relief. In 2004, Grubb & Ellis Valuation and Advisory Group (“Defendant”) was retained by order of the bankruptcy court as an estate professional to appraise the value of Plaintiff’s real property. The appraisal was used to determine the amount to be paid to Plaintiff in a settlement with his former partners, and such payment was used to fund Plaintiff's confirmed plan, which provided for 100% recovery to creditors. Thereafter, Defendant filed a fee application seeking to recover its fees. Plaintiff filed an objection to the fee application, arguing that the appraisal resulted in a lower valuation and lower payment to the estate. Plaintiff sought damages asserting that, if the property had been appraised at a higher value, funds would have been left over for Plaintiff personally. The bankruptcy court approved Defendant's fee over Plaintiff's objection and rejected Plaintiff’s request to treat the objection as a counterclaim. Plaintiff then filed an action against Defendant in state court, alleging $1 million in damages arising from the appraisal. Defendant removed the action to the federal district court, and the case was thereafter transferred to the bankruptcy court by stipulation of the parties. Plaintiff disputed Defendant's allegation that the case was a “core” proceeding and moved to remand the case to state court. Finding the case to be a core proceeding within the meaning of 28 U.S.C. § 157(b) because it arose out of work performed on behalf of the estate by a professional retained and paid by order of the bankruptcy court, the bankruptcy court entered an order denying Plaintiff's motion to remand or abstain and, thereafter, dismissed all claims on Defendant's motion for judgment on the pleadings. On appeal, the district court affirmed in part and reversed in part, finding that, although a close call as to whether Plaintiff sufficiently plead claims of gross negligence and intentional wrong, there was an allegation in the pleadings that could potentially cause a juror to find gross negligence or intentional wrong. On remand to the bankruptcy court, Plaintiff filed a demand for a jury trial.

The Bankruptcy Court’s Power to Enter a Final Order

Beginning its analysis, the bankruptcy court explained that, pursuant to 28 U.S.C. § 1334(b), bankruptcy courts have subject matter jurisdiction over adversary proceedings “arising under,” “arising in” and “related to” cases under title 11. Further, the bankruptcy court noted that 28 U.S.C. § 157(b)(1) authorizes bankruptcy judges to hear all cases under title 11 and all “core” proceedings arising under or arising in a title 11 case. Next, examining the bankruptcy court’s power to enter final orders, the bankruptcy court reviewed the recent decision of the Supreme Court in Stern v. Marshall in which it held that § 157(b)(2)(C), which provides that “core” proceedings include counterclaims by the estate against parties filing proofs of claim, was unconstitutional. According to the bankruptcy court, Stern held that a bankruptcy court, as an Article I court, lacked the power to adjudicate a debtor’s prepetition state law claim for tortious interference where such cause of action was not fully determined in the claims allowance process and, instead, such state law claims should be adjudicated by an Article III court because Article III court judge's life tenure and non-diminution of salary preserve their impartiality. Then, the bankruptcy court observed that, post-Stern, federal courts have revisited the bankruptcy courts’ power to enter final orders in actions grounded in state law. After noting that the “core” versus “non-core” distinction remains relevant, the bankruptcy court instructed that, when deciding whether it has the power to adjudicate a matter, a bankruptcy court must examine the nature of the proceeding beyond whether it is listed as a “core” proceeding and decide whether a sufficient connection exists to the “restructuring of debtor-creditor relations” to permit final adjudication by the bankruptcy court.

The Matter was a Core Proceeding within Bankruptcy Court’s Authority

Against this standard, the bankruptcy court rejected Plaintiff’s contention that its gross negligence claim was a counterclaim to the fee application and, as such, within the scope of proceedings that Stern held could not be finally adjudicated by a bankruptcy court. The bankruptcy court clarified that, because the fee application requested payment from the estate but did not assert a cause of action against Plaintiff personally, the objection could not be a counterclaim. Instead, the bankruptcy court found the instant action to be a proceeding concerning the administration of the estate within § 157(b)(2)(A) because it arose out of work performed on behalf of the estate by a professional retained and paid by order of the bankruptcy court. Further, the bankruptcy court found that the gross negligence claim could not be characterized as a counterclaim within the scope of § 157(b)(2)(C), as the claim was not by the estate but instead by the debtor personally. Finding that Stern’s application was narrow -- limited to § 157(b)(2)(C) -- leaving the other examples of “core” proceedings contained in 28 U.S.C. § 157(b)(2) unaffected, the bankruptcy court held that, as the action was a “core” matter pursuant to § 157(b)(2)(A) as opposed to pursuant to § 157(b)(2)(C), the bankruptcy court's authority to adjudicate it was unaffected by Stern. In addition, the bankruptcy court rejected Plaintiff’s position that its claim could stand alone, finding that the gross negligence claim was inextricably intertwined with the bankruptcy. In so ruling, the bankruptcy court was persuaded by the holding in Southmark Corp. v. Coopers & Lybrand LLP (In re Southmark Corp.), 163 F.3d 925, 931 (5th Cir. 1999), that a malpractice claim involving services performed by estate accountants and the fees awarded by the bankruptcy court was inextricably intertwined with the bankruptcy and, thus, could not stand alone. Finally, the bankruptcy court concluded that whether the bankruptcy court had the authority to conduct a jury trial was not at issue, as bankruptcy courts in the Southern District of New York have the authority to conduct jury trials pursuant to 28 U.S.C. § 157(e) and General Order M-139, and that the only remaining questions before the court were whether the jury demand was timely and whether the parties expressly consent to a jury trial before the bankruptcy court. Finding that such questions were not ripe until the case became trial-ready, the bankruptcy court postponed its decision regarding the proper forum for a jury trial until the case became trial-ready and the parties have the opportunity to brief the issues.

Bankruptcy Court Reaffirms Prior Ruling

In sum, the bankruptcy court held that the proceeding was a “core” proceeding involving the administration of the estate that was inextricably intertwined with the bankruptcy, empowering the bankruptcy court to enter final orders in the case. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.  

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