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Bankruptcy Court Cannot Decide State Law Claims: U.S. Supreme Court: Marshall v Marshall

Who would have thought that an endless lawsuit involving the late Anna Nicole Smith might be the vehicle for the Supreme Court to curtail the constitutional jurisdiction of Bankruptcy Courts? But the United States Supreme Court, in a 5-4 decision along the usual ideological lines, ruled bankruptcy courts do not have the constitutional power to make a final ruling on issues strictly of state law, saying that only judges appointed under Article III of the Constitution (lifetime appointment District Court Judges) have that authority. Marshall v. Marshall; United States Supreme Court decision June 23, 2011.

The majority opinion of Chief Justice Roberts opens on a lighter note, quoting Charles Dickens:

This "suit has, in course of time, become so complicated, that . . . no two . . . lawyers can talk about it for five minutes, without coming to a total disagreement as to all the premises. Innumerable children have been born into the cause: innumerable young people have married into it;" and, sadly, the original parties "have died out of it." A "long procession of [judges] has come in and gone out" during that time, and still the suit "drags its weary length before the Court." Those words were not written about this case, see C. Dickens, Bleak House, in 1 Works of Charles Dickens 4-5 (1891), but they could have been.

The person we all knew as Anna Nicole Smith was actually named Vickie Lynn Marshall, third wife to the elderly and fabulously wealthy oil tycoon J. Howard Marshall II. In a prime-time soap opera drama, Vickie (call that throughout the Supreme Court decision) sued Pierce Marshall, son of J. Howard (called Pierce throughout as well) before the old man died, claiming that Pierce induced his father to cut Vickie out of his will.

The exact legal claim against Pierce was "tortious interference with a gift." As J. Howard lived and died in Texas, that state's law was applicable, and it was unclear whether Texas law recognized as a valid claim "tortious interference with a gift."

Meanwhile, after the old man's death, Vickie filed bankruptcy in California. Pierce, not much liking Vickie's attitude, filed a claim in her bankruptcy case, for defamation (as described by the majority opinion, Pierce claimed that Vickie "defamed him by inducing her lawyers to tell members of the press that he had engaged in fraud to gain control of his father's assets." Vickie objected to the claim, in part by counter-claiming (as part of the claims objection process) her tortious interference with a gift argument.

Meanwhile the estate of J. Howard was probated in Texas state court. And along the way, both Vickie and Pierce passed away (he in 2006, she in 2007), but the litigation lived on (hence the Bleak House quote.) The actual caption of the Supreme Court case is "Howard K. Stern, Executor of the Estate of Vickie Lynn Marshall, petitioner, v. Elaine T. Marshall, Executrix of the Estate of E. Pierce Marshall." By the way, Wikipedia describes Mr. Stern as an attorney and former "domestic partner" of Vickie, and it gets worse from there, but I digress.

The various legal cases went around and around, but for our purposes, the chief bankruptcy question was whether the Bankruptcy Court in California had the constitutional authority to decide Vickie's tortious interference with a gift Texas state law counterclaim. The five member majority decided that Bankruptcy Court does not, as bankruptcy is not an "Article III" court.

Article III of the United States Constitution sets up the third branch of government, the federal judiciary. Federal judges must be appointed by the president and confirmed by the senate; their appointment is for life (absent impeachment) and their salaries may not be reduced during their time in office. The intent was to insulate the judiciary from undo influence by other branches of government (or the public, for that matter.) Judges who were subjected to fixed terms might try to ingratiate themselves with the executive, to win reappointment, and similarly if their pay could be cut by a legislature disapproving some decision they might be unfairly deferential.

Bankruptcy judges are appointed by the United States Circuit Courts of Appeals (the successor to Rochester Bankruptcy judge John C. Ninfo II is going through that process right now). They are appointed for fourteen year terms. Therefore they are not Article III judges.

Congress attempted to avoid the problem by having the Courts of Appeal appoint the judges, in effect making them an adjunct of District Court, but the Marshall majority concluded that only judges appointed under Article III are bonafide federal judges. Congress can, if it wishes, set up other tribunals to carry out specific federal statutes; so, for example, the Office of Disability Adjudication and Review determines social security disability eligibility disputes.

If I am reading Marshall v. Marshall correctly, the majority opinion basically says bankruptcy judges are little more than administrative law hearing officers, empowered to administer the Bankruptcy Code and nothing else.

Specifically in this case, the Marshall majority stated that a bankruptcy judge was not empowered to determine an issue strictly of state law (Vickie's tortious interference with a gift counter-claim under Texas law.) Those questions can only be determined by state court or by federal district court judges.

What is the practical effect of this decision on average bankruptcy debtors? My analysis is that one particular piece of litigation - a trustee lawsuit against a third party to avoid a fraudulent conveyance under state law (in New York, Debtor and Creditor law Sections 270-279) - cannot be litigated in bankruptcy court. It is possible that all sorts of other claims by trustees against third parties, such as avoiding preferential payments under Bankruptcy Code Sect. 547 or fraudulent conveyance under Section 548, cannot be litigated in bankruptcy court, but must be determined by a bonafide Article III district court judge. If so, many small potatoes lawsuits filed routinely by bankruptcy trustees today will be abandoned as not worth the litigation cost of proceeding in District Court.

It is possible that the courts will work around the issue by having the bankruptcy judge hold hearings and propose a finding of fact and conclusion of law to the district court judge, who will make the final binding decision. Even this step would increase the workload of already-overburdened district courts and drive up the cost of bankruptcy litigation.

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