Can’t Touch This: Mandatory Abstention in the Wake of Stern v. Marshall

The poetic prose of Bob Dylan unintentionally captured the essence of modern bankruptcy jurisdiction with this simple observation: the times they are a changin’. In the past four years, the foundation of bankruptcy jurisdiction has been permanently altered by the violent earthquake known as Stern v. Marshall. Cracked and falling apart piece by piece, the pillars supporting bankruptcy judges’ authority have begun to crumble and disintegrate, leaving bankruptcy enthusiasts to wonder whether the system may altogether collapse. In the post-Stern world, bankruptcy judges must not only grapple with the two-tiered structure of statutory vs. constitutionally core and non-core claims, but must now also face a quiet threat lurking in the shadows: mandatory abstention. This article analyzes the circumstances under which bankruptcy judges are required to abstain from hearing a case in light of Stern, thus exposing yet another wrinkle in the constantly evolving structure of bankruptcy jurisdiction.

I’m Too Sexy For This Case: Understanding Mandatory Abstention

The term “abstention” generally refers to a judicially-created doctrine designed to respect and delineate the boundaries between the state and federal judiciary. Pursuant to this doctrine, a judge will refuse to hear a case that intrudes upon the powers of another court. At its most basic level, abstention prohibits state courts from issuing federal constitutional rulings and limits the power of federal judges to adjudicate state law claims. In the context of bankruptcy cases, however, abstention is statutory, not judicial. See 28 U.S.C. § 1334(c). This statutory framework illuminates two categories of abstention when faced with bankruptcy claims: (1) mandatory abstention; and (2) permissive abstention.

Mandatory abstention seeks to strike a balance between the competing interests of federal bankruptcy courts and state courts. In its simplest form, mandatory abstention prevents federal courts from hearing non-core matters that can be timely adjudicated in a pending state court action. See In re Mercer’s Enters., Inc., 387 B.R. 681, 684 (Bankr. E.D.N.C. 2008). Requests for mandatory abstention must arise by motion of a party and may not be raised sua sponte by the court. Because mandatory abstention strips a bankruptcy court of its power to adjudicate a claim over which it possesses federal subject matter jurisdiction, the doctrine may only be invoked if six elements are satisfied: (1) a party has timely submitted a motion to abstain; (2) the cause of action is based upon a state law claim; (3) the action is a non-core proceeding (i.e. the action is “related to” the bankruptcy proceeding but does not “arise in” or “arise under” a Title 11 case); (4) the bankruptcy court would not otherwise have jurisdiction over the action outside of Section 1334; (5) the action was already pending in state court when the bankruptcy case was filed; and (6) the action may be timely adjudicated in the state court. See In re Constr. Supervision Servs., Inc., Ch. 11 Case No. 12-00569-8-RDD, Adv. No. 12-00111-8-RDD, 2012 WL 2993891, at *3 (Bankr. E.D.N.C. July 20, 2012); In re Mercer’s Enters., Inc., 387 B.R. at 684. Failure to prove any element of this test eliminates mandatory abstention as a remedy.

In the absence of mandatory abstention, a court may nevertheless choose to permissively abstain from adjudication of a case. While mandatory abstention applies solely to non-core proceedings, permissive abstention is available for core claims. This voluntary form of abstention may be exercised “in the interest of justice, or in the interest of comity with State courts or respect for State law.” 28 U.S.C. § 1334(c)(1). When determining whether permissive abstention is appropriate, bankruptcy courts in North Carolina employ a twelve-factor test that includes examination of the applicable law, the closeness of the claim with the main bankruptcy case, feasibility of severing the claims, the burden on the bankruptcy court’s docket, concerns regarding forum shopping, and the extent to which state law issues dominate over bankruptcy issues. See In re Pettus Props., Inc., Ch. 11 No. 10-31632, Adv. No. 11-3213, 2012 WL 956915, at *3 (Bankr. W.D.N.C. Mar. 20, 2012); In re Freeway Foods of Greensboro, Inc., 449 B.R. 860, 879 (Bankr. M.D.N.C. 2011); In re Newell, 424 B.R. 730, 735-36 (Bankr. E.D.N.C. 2010). Thus, permissive abstention is within the discretion of the bankruptcy court and is used primarily for core proceedings.

Where the Wild Things Are: Core vs. Non-Core Claims

As evidenced by the third prong of the mandatory abstention test and the structure of permissive abstention, Section 1334(c) must be read in conjunction with 28 U.S.C. § 157(b), which delineates the distinction between core and non-core claims. This seemingly artificial divide between categories of bankruptcy actions arose in response to the Supreme Court’s decision in Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), which stated that judicial power could only be vested in an independent judiciary protected by Article III safeguards. In other words, because bankruptcy judges did not qualify as Article III judges, Congress did not have the power to grant them broad jurisdiction over state-created private rights of action arising independent from the bankruptcy proceeding. Faced with this holding, Congress passed the Bankruptcy Amendments and Federal Judgeship Act of 1984, which identified two categories of bankruptcy proceedings—core and non-core—in an effort to amend the bankruptcy court’s jurisdictional reach.

Core proceedings encompass those claims that are directly related to the bankruptcy court’s central functions. These claims must either “arise in” or “arise under” a Title 11 case. See 28 U.S.C. § 157(b). To be considered a core proceeding, the claim must not be able to exist in law in the absence of the Bankruptcy Code. Thus, a proceeding is core only if it invokes a substantive right created by federal bankruptcy law. All core proceedings may be heard by a bankruptcy judge, who possesses authority to enter final judgment on the merits.

On the other hand, a claim is considered non-core if it is simply related to the underlying bankruptcy case. See 28 U.S.C. § 157(c). A proceeding is related to a bankruptcy case if the outcome of the action could conceivably have an effect on the administration of the bankruptcy estate. A non-core claim thus exists outside the bankruptcy action and is one that can be asserted in the absence of the Bankruptcy Code. A non-core claim, however, may not be finally adjudicated by the bankruptcy court absent the parties’ consent. Rather, barring consent the bankruptcy judge may only submit proposed findings of fact and conclusions of law to the district court for review.

Round and Round Here We Go Again: A Brief Recap of Stern

Although the bifurcated structure of bankruptcy jurisdiction into core and non-core claims existed peacefully for almost three decades, the Supreme Court reshaped the structure of bankruptcy authority overnight with its decision in Stern. According to Stern, it is no longer sufficient for bankruptcy judges to simply categorize proceedings as statutorily core or non-core. Instead, bankruptcy courts must analyze both the statutory and constitutional foundations for jurisdiction. This two-step inquiry limits bankruptcy judges to adjudicating claims that fall within one of two categories: (1) those that arise in the bankruptcy case itself; and (2) those that necessarily would be resolved in the claims allowance process. While a bankruptcy court may acquire jurisdiction by satisfying either prong, failure of both prongs restricts a bankruptcy judge to the entry of proposed findings of fact and conclusions of law for the district court’s review. Therefore, although Section 157 sets forth the statutory foundation for bankruptcy jurisdiction, the Supreme Court has imposed a second layer of analysis by requiring compliance with constitutional standards.

Leave the Pieces When You Go: Mandatory Abstention in Light of Stern

The confusion and controversy surrounding Stern and its recently decided progeny, Executive Benefits Insurance Agency v. Arkison, has forced bankruptcy judges and practitioners to question the implications of these decisions on the doctrine of mandatory abstention. Specifically, Stern left unresolved the question of whether bankruptcy courts must abstain from adjudicating statutorily core but constitutionally non-core proceedings. Although North Carolina courts have not yet addressed the issue, bankruptcy courts across the country recognize that the constitutional inquiry implicated in Stern does not figure into the mandatory abstention analysis. In other words, mandatory abstention is dictated solely by a proceeding’s classification as statutorily core or non-core.

The Bankruptcy Court for the Southern District of New York succinctly summarized this principle when it held that Stern and Executive Benefits Insurance Agency did not re-write Section 157 to transform Stern claims into statutorily non-core proceedings. In re Residential Capital, LLC, 515 B.R. 52, 66 (Bankr. S.D.N.Y. 2014). Rather, the court explained that the statutory and constitutional inquiries are separate and distinct. A constitutionally non-core claim will not require a bankruptcy court to abstain from adjudication altogether, it merely limits it to issuing proposed findings of fact and conclusions of law.

Similarly, the Southern District of Texas articulated that Stern’s imposition of a constitutional test “does not alter the statutory test for determining whether a proceeding is core.” Shipley Garcia Enters., LLC v. Cureton, No. M-12-89, 2012 WL 3249544, at *10 (S.D. Tex. Aug. 7, 2012). The test for statutorily core claims remains whether the case arises in or arises under a Title 11 case. Stern, by its very language, does not implicate questions of subject matter jurisdiction. While Stern prohibits bankruptcy courts from entering final judgment on certain counterclaims deemed to be constitutionally non-core, “it did not rewrite the statute and reclassify those claims as ‘related to’ proceedings” under Section 157(c)(1) or Section 1334(c). Id.

The Bankruptcy Court for the Northern District of Iowa espoused similar reasoning in its 2012 case, In re Civic Partners Sioux City, LLC, Ch. 11 Case No. 11-00829, Adv. No. 11-9045, 2012 WL 761361 (Bankr. N.D. Iowa Mar. 8, 2012). The court held that the additional layer of analysis imposed by Stern was not required when examining the basis for mandatory abstention. Id. at *7. In support of this argument, the court noted that the language in Stern was purposefully concise and limited so as to emphasize the narrowness of its holding. By its express terms, Stern only examined the constitutional foundations for bankruptcy authority and “did not strike the entire structure in 28 U.S.C. § 157 allocating the division of authority into core and non-core proceedings.” Id. at *8. Therefore, an analysis of mandatory abstention turns solely on the classification of a proceeding as statutorily core or non-core. The constitutional analysis set forth in Stern is inapplicable.

The reasoning espoused by the Bankruptcy Court for the Southern District of New York, the Southern District of Texas, and the Bankruptcy Court for the Northern District of Iowa is inherently sound. Stern deals solely with the authority of a bankruptcy judge to enter a final judgment on the merits, and does not alter the statutory classifications of claims as core or non-core. When faced with a Stern claim (i.e., a proceeding that is statutorily core but constitutionally non-core), North Carolina courts should refrain from mandatory abstention and engage solely in an analysis of permissive abstention, if applicable. A claim’s categorization as constitutionally non-core is immaterial to its statutory classification as core. Because mandatory abstention deals solely with a proceeding’s statutory description, Stern is irrelevant to the abstention inquiry.

Conclusion

Cases addressing mandatory abstention in the aftermath of Stern have come to an easily understandable conclusion: Stern is entirely separate and has no bearing on the doctrine of mandatory abstention. Rather, the only question is whether the claim itself is statutorily core. The fact that a claim may be constitutionally non-core is irrelevant to the mandatory abstention inquiry. Therefore, a claim that is statutorily core under Section 157 but only related to the bankruptcy case would still result in the claim being treated as overall core for mandatory abstention. Thus, only the claim’s categorization under Section 157 matters for the abstention analysis.

Bethany Corbin is an associate at Bradley Arant Boult Cummings in Charlotte, North Carolina. She previously served as a law clerk to the Honorable Lena M. James, United States Bankruptcy Court for the Middle District of North Carolina, and will clerk for the United States Court of Appeals for the District of Columbia beginning in August 2016.

Republished with permission. This article first appeared in pages 17-18 of Disclosure Statement, a publication of the North Carolina Bar Association, Volume 36, No. 2, on April 2015.