The future of federal courts

The U.S. Supreme Court's January 2015 argument calendar has several high-profile cases. But from a practical perspective, the case that may be of greatest significance - and of enormous importance to litigation in the federal courts - is one that likely will get little media attention. Wellness International Network, Limited v. Sharif, 13-935, which will be argued Wednesday, focuses on whether bankruptcy judges can decide a matter outside of their authority with consent of the parties.

If the court holds they cannot, it will affect not only bankruptcy court litigation, but the power of magistrate judges and even potentially arbiters. It could have a tremendous impact on the workload of federal district courts.

In Stern v. Marshall, 131 S.Ct. 2594 (2011), the Supreme Court ruled that bankruptcy courts cannot constitutionally issue a final judgment over state law claims unless they stem from the bankruptcy itself. The case received attention because it involved Anna Nicole Smith, who married a very rich man in Texas, J. Howard Marshall. Although Marshall had given many gifts to Smith, his will left her nothing.

Smith, referred to in this litigation as Vicki Lynn Marshall, filed for bankruptcy. Marshall's son, Pierce Marshall, filed a proof of claim in her bankruptcy proceeding. Pierce contended that Vicki had defamed him in asserting that Pierce had exercised undue influence over his father to deny her an inheritance. Vicki counter-claimed, asserting that he had tortiously interfered with her recovery under the estate.

The bankruptcy court ruled in favor of Vicki on her counter-claim and awarded her $449 million in compensatory damages and $25 million in punitive damages. The federal district court affirmed the ruling in favor of Vicki, but reduced her recovery to $88 million, evenly divided between compensatory and punitive damages.

Between the ruling by the bankruptcy court and that of the district court, a probate court in Texas decided entirely in favor of Pierce. There thus was an issue of preclusion. If the bankruptcy court had the authority to issue a final judgment, then the Texas probate court's ruling was precluded and Vicki - or more precisely, her estate since she is no longer alive - wins. But if the bankruptcy court lacked the authority to issue a final judgment, then Pierce - or more precisely, his estate since he is no longer alive - wins.

The Stern court ruled 5-4 in favor of Pierce. Chief Justice John Roberts wrote the opinion for the court and held that it violated separation of powers for Congress to allow non-Article III bankruptcy judges, who lack life tenure and protection of their salary, the ability to issue a final judgment over state law claims unless they stem from the bankruptcy itself. The court declared: "Article III could neither serve its purpose in the system of checks and balances nor preserve the integrity of judicial decisionmaking if the other branches of the Federal Government could confer the Government's judicial power on entities outside Article III." The court rejected Justice Stephen Breyer's claim in dissent that this would create a practical nightmare for the federal district courts.

The significance of Stern turns on whether consent can cure the problem. Usually, the parties will consent to allow the bankruptcy court to issue a final judgment. But if consent is not sufficient, then the implications are enormous. A significant percentage of bankruptcy cases have state law claims that do not stem from the bankruptcy itself. The bankruptcy courts instead must make reports and recommendations to the district court. As Breyer feared, cases will pingpong back-and-forth between the bankruptcy courts and the district courts.

The workload increase for already overtaxed federal district courts will be great. As Breyer pointed out in his dissent in Stern, "the volume of bankruptcy cases is staggering, involving almost 1.6 million filings last year, compared to a federal district court docket of around 260,000 civil cases and 78,000 criminal cases."

If bankruptcy courts cannot issue final judgments on these state law claims with the consent of the parties, then district courts must do so. No longer will the bankruptcy appellate panels be able to decide such matters because they are limited to reviewing decisions of bankruptcy courts.

The implications for the federal judicial system go far beyond that. Federal magistrate judges issue final judgments in civil cases, including holding jury trials, with the consent of the parties. Magistrate judges, like bankruptcy judges, are non-Article III judges who sit for fixed terms. If consent is not sufficient, no longer could they decide state law matters. The workload increase for federal district courts will be great.

There is no clear answer to whether consent is sufficient to allow a bankruptcy court to issue a final judgment over state law claims. On the one hand, it is possible to distinguish subject matter jurisdiction, which cannot be gained by consent, and the authority to issue a final judgment, which arguably can be gained by consent. Arbiters, who are not Article III judges, effectively have this authority all the time.

On the other hand, both limits on subject matter jurisdiction and limits on the authority to issue a final judgment are based on Article III of the Constitution. Both are structural constitutional limits and structural limits cannot be overcome by consent.

Not surprisingly, there is a split among the federal courts of appeals whether a bankruptcy court can issue a final judgment with consent of the parties. The Supreme Court had this same issue before it last year and then did not decide it. The 9th U.S. Circuit Court of Appeals, in In re Bellingham Ins. Agency, 702 F.3d 553 (9th Cir. 2012), ruled that consent is permissible and that it can be implied consent. The Supreme Court granted review and then did not decide the consent question, instead unanimously holding it was unnecessary to reach the issue because there had been de novo review in the federal district court. Executive Benefits Insurance Agency v. Arkison, 134 S.Ct. 2165 (2014).

Almost immediately, the court then granted review in Wellness International Network v. Sharif, where the 7th U.S. Circuit Court of Appeals had come to the opposite conclusion to that of the 9th Circuit, and held that consent cannot be a basis for a bankruptcy court to issue a final judgment that is not permissible under Stern.

The case involves a $655,000 judgment against Richard Sharif that was obtained by Wellness International Network. Sharif filed a Chapter 7 bankruptcy action and sought to discharge the debt. Wellness International brought an adversary proceeding against Sharif in the bankruptcy court, which ultimately entered a default judgment against Sharif. The 7th Circuit, however, ruled that Sharif's failure to object to the bankruptcy court's jurisdiction did not give it authority to decide the case. The 7th Circuit said that consent was not permissible because "it implicates separation of powers principles," not just personal rights of the litigants.

If the Supreme Court agrees with the 9th Circuit's approach, the problems created by Stern will be largely solved. But if the court affirms the 7th Circuit, there will be a huge effect for bankruptcy judges, magistrate judges, and federal district court judges and those who litigate before them.