Renewing the Constitution’s “Bankruptcies” Clause for Bankruptcy Court Jurisdiction

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Renewal (photo by Marilyn Swanson)

By: Donald L Swanson

Back in 1966, when the Bankruptcy Act of 1898 was newly-eligible (in human years) for Social Security, the U.S. Supreme Court issued a 7 to 2 majority opinion in Katchen v. Landy, 382 U.S. 323 (1966).

The Katchen opinion is founded in the U.S. Constitution’s “Bankruptcies” clause and authorizes bankruptcy courts to resolve claim objections and related preference claims without a jury trial.  

Here is the essence of the opinion’s rationale:

    (1) The Constitution’s “Bankruptcies” clause (in Art. I, Sec. 8) [Fn. 1] empowers Congress to pass uniform bankruptcy laws;

    (2) The bankruptcy scheme adopted by Congress (under its “Bankruptcies” clause power) “converts” a creditor’s legal claim “into an equitable claim to a pro rata share of the res”; so,

     (3) There “is no Seventh Amendment right to a jury trial” for determination of objections to claims, including a related preference claim.

Since then, the Constitution’s “Bankruptcies” clause has been abandoned as a basis for Bankruptcy Court jurisdiction [Fn. 2].  And it needs to be renewed!

Theory v. Reality

The theory is this:

Powers granted to Congress under the Constitution’s “Bankruptcies” clause are the foundation for bankruptcy court jurisdiction.  Katchen confirms this point.

—Who can argue with that?  And who would ever think otherwise?

But the reality is this:

Never again, since Katchen v. Landy, has a U.S. Supreme Court majority relied on the Constitution’s “Bankruptcies” clause to decide the jurisdiction of bankruptcy courts [id.].  Most notably, the “Bankruptcies” clause is not even mentioned in majority opinions on such issues (see, e.g., this linked article).

—How can this be?

Katchen v. Landy Summarized

The Katchen v. Landy opinion makes sense.  Here is a summary.

—The question

Do bankruptcy courts have jurisdiction to rule on a preference claim against a creditor who files a proof of claim?

—The facts

Katchen guaranteed loans to his corporation totaling $50,000 and made sure these loans were paid with corporate funds.  Then, the corporation filed bankruptcy.  Katchen filed two claims in the bankruptcy: one for unpaid rents and one for reimbursement of his payment on another guaranty.

Then, the bankruptcy Trustee sued Katchen, as guarantor, to recover the corporate loan payoffs as preferences.  The Trustee obtained a judgment against Katchen, over his jurisdiction objection.

On appeal, the District Court affirmed, as did a divided Court of Appeals.

—The Supreme Court Opinion

The 7 to 2 majority opinion in Katchen says:

Under “Bankruptcies” clause authority, the National Bankruptcy Act of 1898 granted bankruptcy courts “original jurisdiction” as “courts of equity” to “deal with the assets” [the “res”] of the bankrupt “over which they have actual or constructive possession”;

Bankruptcy courts can also deal with administrative matters, “including questions between the bankrupt and his creditors”—this is “elementary bankruptcy law”;

A “chief purpose” of bankruptcy is “to secure a prompt and effectual administration and settlement of the estate of all bankrupts,” and dispensing with the “usual modes of trial” that cause delay “is one of the means chosen by Congress to effectuate that purpose”;

The power to “allow,” “disallow” and “reconsider” claims, is of “basic importance” in bankruptcy and includes the power to “inquire into the validity” of a claim and deny it until preference amounts are repaid—”the bankruptcy court has jurisdiction over such matters in their entirety”; 

Filing a proof of claim in bankruptcy invokes the bankruptcy court’s jurisdiction and subjects the creditor “to all the consequences that attach to an appearance”—this rule is “in harmony” with the courts-of-equity rule that, “having jurisdiction of the parties to controversies brought before them,” courts-of-equity “will decide all matters in dispute and decree complete relief”; and

The 7th Amendment right to jury trial “does not extend to cases of equity jurisdiction”—so, “many incidental questions” in “administering the bankrupt estate” would “ordinarily” be “triable by jury,” but a bankruptcy court can try such questions without a jury, “as a court of equity.”

Congressional Action—1984

Congress adopted the Bankruptcy Code in 1978 and amended it in 1984 — all under “Bankruptcies” clause authority.  The amendment clarifies jurisdiction of bankruptcy courts by distinguishing between “core” and “related to” matters, with final order / proposed findings effects [28 U.S.C. Sec. 157].

The 1984 amendment, in reliance on Katchen v. Landy, identifies “counterclaims by the estate against persons filing claims against the estate” as “core” proceedings  on which the Bankruptcy Court can issue a final ruling [28 U.S.C. Sec. 157(b)(2)(C)].

You’d think Katchen v Landy (with its focus on the Constitution’s “Bankruptcies” clause) would continue to prevail under the Bankruptcy Code and the 1984 amendment.  But it doesn’t.

Subsequent Supreme Court Opinions

The following are Supreme Court opinions, since 1984, showing how the “Bankruptcies” clause has been ignored on jurisdiction issues — but with some recent progress in the right direction.

–Granfinanciera—1989

The Supreme Court’s first crack at the 1984 amendment came in 1989—in Granfinanciera v. Nordberg.

Granfinanciera filed an fraudulent transfer case in Bankruptcy Court against Nordberg under Sec. 548 of the Bankruptcy Code.

Nordberg demanded a jury trial under the U.S. Constitution’s 7th Amendment.  The Supreme Court agreed with his demand—contrary to the teaching of Katchen v. Landy.  In doing so it, (i) failed to even mention the Constitution’s “Bankruptcies” clause, (ii) founded its decision on a “public rights” doctrine under Article III of the U.S. Constitution, and (iii) insisted that the Katchen v. Landy opinion “confirms this analysis.”

The only focus in Granfinanciera on the “Bankruptcies” clause comes from Justice Blackmun’s dissent, where he says:

Congress should be permitted, under that clause and “at long last,” to “fashion a modern bankruptcy system which places the basic rudiments of the bankruptcy process in the hands of an expert equitable tribunal”;

The majority opinion “throws Congress into still another round of bankruptcy court reform, without compelling reason”; and

“There was no need for us to rock the boat in this case.”

Justice Blackmun had it right.  But ignoring the “Bankruptcies” clause for bankruptcy court jurisdiction continued in cases that followed.

–Stern v. Marshall—2011

In Stern v. Marshall, the Debtor’s step-son filed a defamation proof of claim in Debtor’s bankruptcy.  The bankruptcy estate objected to that claim and filed compulsory counterclaims against the step-son for common-law torts.

Stern’s 5-Justice majority relies on “public rights” doctrine under Article III and distinguishes Katchen v. Landy on technical grounds.  But it refuses to even mention, let alone discuss, the role of the Constitution’s “Bankruptcies” clause in the matter.

–Wellness International v. Sharif—2015

The bankruptcy estate filed a five-count adversary complaint against Sharif in Bankruptcy Court.  Four counts  objected to Sharif ’s discharge.  The fifth asserted an “alter ego” claim against assets of a trust.

The Supreme Court’s 6-Justice majority said the Bankruptcy Court had jurisdiction over the “alter ego” claim, based on consent of the parties.

The Wellness Dissent Signals a Change?

What’s remarkable about the Wellness case is the dissent by three Justices, who are committed to the “public rights” doctrine and its limitation on bankruptcy court jurisdiction. In an apparent effort to forestall the majority’s jurisdiction-by-consent conclusion, the dissenters take a surprising tack:

—They contend the “alter ego” claim is a “core” matter—and not a Stern claim at all.

Here’s what the dissenting opinion says:

An “alter ego” claim “stems from the bankruptcy itself”—not from “the stuff of the traditional actions at common law tried by the courts at Westminster in 1789”;

“Article III poses no barrier to such a decision”; and 

 “That is enough to resolve this case.”

Katchen v. Landy is the centerpiece of the dissent’s rationale.  Here’s how:

Article III “poses no barrier” to the Bankruptcy Court resolving Wellness’s “alter ego” claim because Bankruptcy is “an adjudication of inter­ests claimed in a res” (citing and quoting Katchen); and

“Identifying property that constitutes the estate [the res] has long been a central feature of bankruptcy adjudication” and is “peculiarly a bankruptcy power.”

The dissent, to be sure, distinguishes its Wellness position from fraudulent conveyance disputes (i.e., Granfinanciera) and contract disputes (i.e., Northern Pipeline) and tort disputes (i.e., Stern v. Marshall).

But the dissent focuses on Katchen, and its jurisdiction-over-the-res rationale that’s based on the Constitution’s “Bankruptcies” clause.  That is new.  And it’s a welcome return to the real source of bankruptcy court jurisdiction and authority.

The Significance

The Supreme Court has gone through a progression on bankruptcy court jurisdiction under the Bankruptcy Code:

Beginning with antagonism in Northern Pipeline and Granfinanciera;

To a slim majority restraining Bankruptcy Court jurisdiction in Stern v. Marshall;

 To a 6-Justice majority expanding Bankruptcy Court jurisdiction by consent in Wellness; and

To a 3-Justice Wellness dissent harkening back to Katchen, with its reliance on the Constitution’s “Bankruptcies” clause for defining bankruptcy court jurisdiction. 

That, I suggest, is progress in the right direction—toward renewal.

Conclusion

Hopefully, one day, a solid majority of Justices on the U.S. Supreme Court will return to their Katchen roots and renew the Constitution’s “Bankruptcies” clause as a basis for upholding Congress’s designations of bankruptcy court jurisdiction.

It appears that the Supreme Court may be getting close to doing so.

Footnote 1:  The Constitution’s “Bankruptcies” clause says: “The Congress shall have Power . . . To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.”

Footnote 2:  The nearest thing to an exception is the “Bankruptcies” clause versus 11th Amendment sovereign immunity rights case: Central Virginia Community College v. Katz, 546 U.S. 356 (2006)).  But Katz proves the point: if the “Bankruptcies” clause prevails against 11th Amendment rights, why isn’t it even mentioned in majority opinions on Article III and 7th Amendment rights?

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

 

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