Fraudulent Transfer Claims — In Constitutional Limbo

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Limbo

By: Donald L. Swanson

we assume without deciding, that the fraudulent conveyance claims in this case are Stern claims.” [Fn. 1]

From unanimous U.S. Supreme Court decision in Executive Benefits Insurance Agency v Arkison (Decided June 6, 2014). [Fn. 2]

It’s a curious thing, this failure-to-decide the constitutional status of fraudulent transfer claims in bankruptcy. Here’s why:

1. Preference claims and fraudulent transfer claims are both listed as “core” proceedings in 28 U.S.C. § 157(b)(2)(F)&(H):

“Core proceedings include, but are not limited to— . . . (F) proceedings to determine, avoid, or recover preferences; . . . (H) proceedings to determine, avoid, or recover fraudulent conveyances”; and

2. In 2006, the Supreme Court rejected constitutional challenges to a pursuit of preference claims in bankruptcy (see Central Virginia Community College v. Katz, 546 U.S. 356 (2006)) in a manner that should apply to fraudulent transfer claims as well.

Central Virginia Community College v. Katz

The U.S. Supreme Court’s Katz ruling affirms a bankruptcy court’s in rem jurisdiction over preference claims against third parties.

But more importantly, Katz affirms a bankruptcy court’s in personum jurisdiction over third parties on ancillary matters as well. And it teaches that such ancillary jurisdiction has been a feature of bankruptcy jurisdiction—from the very beginning.

Here’s how.

In Rem and Ancillary In Personum Jurisdiction

Katz acknowledges that bankruptcy jurisdiction, “at its core,” is “in rem”:

–the “whole [bankruptcy] process of proof, allowance, and distribution is, shortly speaking, an adjudication of interests claimed in a res.”

Yet, Katz explains, ancillary in personum jurisdiction over third parties is essential, as demonstrated by habeas corpus relief from debtors’ prison.

–Debtors’ Prison & Habeas Corpus Relief

Katz highlights the right of habeas corpus (i.e., getting a debtor out of debtor’s prison) as an example of ancillary in personum bankruptcy jurisdiction. Notably, the writ of habeas corpus acts “upon the person who holds [the debtor] in what is alleged to be unlawful custody” and not “upon the prisoner who seeks relief.” Habeas corpus is, therefore, an exercise of ancillary in personum jurisdiction over a third person whose only connection with the bankruptcy is possession of the debtor.

“Foremost on the minds of those” who adopted the Bankruptcy Clause as part of the U.S. Constitution, Katz explains, were the “intractable problems” and “injustice” of “one State imprisoning debtors who had been discharged (from prison and of their debts) in and by another State.”

[Note: Historically, the term “discharge” had a double meaning, referring to both a “release of debts” and a “release of the debtor from prison.” Earliest bankruptcy statutes in England “authorized discharges of persons [from prison], not debts”: e.g., a 1649 statute is titled, “An act for discharging Poor Prisoners unable to satisfy their creditors.”]

Accordingly, courts “adjudicating disputes concerning bankrupts’ estates” had power to issue ancillary in personum orders (such as writs of habeas corpus) to enforce “their in rem adjudications.”

Katz uses the habeas corpus illustration to apply ancillary in personum jurisdiction in a preference action:

A bankruptcy court can avoid a preferential transfer and can “involve” an ancillary “in personam process” (i.e., mandating turnover of the property) “in furtherance of the court’s in rem jurisdiction”; and

“Those who crafted” the U.S. Constitution’s Bankruptcy Clause “would have understood it to give Congress the power to authorize courts to avoid preferential transfers” and, also, “to recover the transferred property.”

The “Courts at Westminster” Distinction

I know. I know. The claimed distinction is that fraudulent transfer claims are state law claims that were among “the stuff of the traditional actions at common law tried by the courts at Westminster in 1789”—and preference claims aren’t.

I understand that distinction. But consider this:

Putting people into (and releasing them from) debtors’ prison was also among those “stuff . . . at Westminster”;

Incarcerations into debtors’ prison, in olden U.S. days, occurred under state laws—not Federal laws; yet

The Supreme Court has never raised Article III concerns about a bankruptcy court’s exercise of in personum jurisdiction over a debtor’s jailer under a writ of habeas corpus.

Questions

1. So . . . why the fastidious—and continuing—concern about ancillary in personum jurisdiction of bankruptcy courts over estate assets held by a fraudulent transferee?

2. What’s materially different between a bankruptcy court:

(i) declaring a debtor’s right to freedom and requiring the jailer to discharge him/her from debtor’s prison, and

(ii) declaring a debtor’s right to recover fraudulently transferred assets and requiring the fraudulent transferee to surrender the transferred asset or its value?

   3. Based on the Katz rationale, how can there be any question about bankruptcy court jurisdiction (both in rem and ancillary in personum) over fraudulent transfer claims and transferees?

Conclusion

The U.S. Supreme Court needs to act. It needs to declare Congress’s categorization of fraudulent transfer claims as “core” proceedings in 28 U.S.C. § 157 to be constitutionally proper.

The failure to do so continues to cause angst and uncertainty in bankruptcy cases—for, I suggest, no valid purpose.

Footnote 1: A Stern claim is: “a claim designated for final adjudication in the bankruptcy court as a statutory matter [28 U.S.C. § 157(b)(2)(H)], but prohibited from proceeding in that way as a constitutional matter” (from Supreme Court’s Executive Benefits opinion).

Footnote 2: This assumption-without-decision, is cited in 2015 by Justice Roberts, dissenting in Wellness International Network, Ltd. v. Sharif.

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