High Court Expands Role of Bankruptcy Courts

(CN) - Bankruptcy courts have the constitutional authority to decide the fate of property in a debtor's possession when all parties agree to let the court decide the case, the Supreme Court ruled Tuesday.

At issue is a five-count adversarial action Wellness International Network brought against its former distributor Richard Sharif after Sharif sought Chapter 7 protection in Illinois bankruptcy court.

Faced with Wellness International's attempts to collect a six-figure judgment that it obtained against Sharif and others in Texas, the bankruptcy court found that Sharif had failed to comply with a majority of the discovery requests related to the case and granted Wellness default judgment - also allowing the Sharif's estate to include a revocable living trust he claimed his mother set up for his sister, deeming the trust Sharif's alter ego.

As Sharif appealed, the Supreme Court was considering bankruptcy issues involved in the estate of Vicki Lynn Marshall, the late Playboy model more popularly known as Anna Nicole Smith. The court's 2011 decision in Stern v. Marshall said that Article III of the U.S. Constitution prohibits bankruptcy courts from finally adjudicating certain bankruptcy-related claims.

Sharif claimed that Stern rendered the bankruptcy court's judgment unconstitutional, but the 7th Circuit largely upheld the default judgment.

In a silver lining for Sharif, however, the court found that the bankruptcy court lacked constitutional authority to enter a decision on the alter-ego claim.

Wellness International petitioned the Supreme Court for relief, claiming that the 7th Circuit misinterpreted Stern v. Marshall and is responsible for "a crippling reduction of the bankruptcy court's authority."

On Tuesday, a divided U.S. Supreme Court upended the 7th Circuit's reversal, finding that when the parties in a bankruptcy case agree to let a bankruptcy court decide the case Article III limits do not apply.

"We conclude that allowing bankruptcy litigants to waive the right to Article III adjudication of Stern claims does not usurp the constitutional prerogatives of Article III courts," Justice Sonya Sotomayor wrote for the majority.

"Congress could choose to rest the full share of the Judiciary's labor on the shoulders of Article III judges," she continued. "But doing so would require a substantial increase in the number of district judgeships. Instead, Congress has supplemented the capacity of district courts through the able assistance of bankruptcy judges. So long as those judges are subject to control by the Article III courts, their work poses no threat to the separation of powers."

In Stern, the parties did not consent to adjudication by the bankruptcy judge. And while Sharif argued he did not give his express consent to let the case be decided by the bankruptcy court, his implied consent was enough to differentiate this case from Stern, the majority held.

Whether or not Sharif impliedly agreed to have Wellness' alter-ego claim decided by the bankruptcy court, however, is a question the 7th Circuit will have to decide, Sotomayor concluded.

Justice Samuel Alito agreed with the majority that bankruptcy courts have the authority to decide Stern claims where there is consent, but dissented on the issue of implied consent.

However, Alito also said Sharif forfeited his Stern objection by not presenting it properly to the 7th Circuit.

In his dissent, Chief Justice John Roberts - joined by Justice Antonin Scalia and in part by Justice Clarence Thomas - wrote that Wellness' alter-ego claim changed the nature of the case and made it constitutionally impossible for the bankruptcy court to decide it, consent or not.

"The court 'expresses no view' on whether Wellness's claim was a Stern claim," Roberts wrote. "Instead, the court concludes that the bankruptcy court had constitutional authority to enter final judgment on Wellness's claim either way. The majority rests its decision on Sharif 's purported consent to the bankruptcy court's adjudication. But Sharif has no authority to compromise the structural separation of powers or agree to an exercise of judicial power outside Article III. His consent therefore cannot cure a constitutional violation."

He continued: "Just as a branch of government may not consent away the individual liberty interest protected by the separation of powers, so too an individual may not consent away the institutional interest protected by the separation of powers."

Such a chipping-away of the judiciary's constitutional powers is an invitation to Congress to give non-Article III judges and magistrates more authority to hear such cases, the chief justice said.

"Ultimately, however, the structural protections of Article III are only as strong as this court's will to enforce them," he concluded, chastising the majority.

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