Bankruptcy Doesn't Have to Be So Messy

The U.S. Supreme Court has grappled with the reach of special bankruptcy courts for years. Today in Executive Benefits Insurance Agency v. Arkison, it came closer to a common-sense answer.
Supreme Court decisions aren't always sexy. They can be sensible.

Bankruptcy courts are the mark of an advanced legal society. Think of the alternatives. Debt-slavery is inhumane. Debtors' prison is inefficient. And breaking a trader's bench and banning him from the market doesn't get anybody's assets back. But how far should the jurisdiction of special bankruptcy courts reach? The U.S. Supreme Court has been grappling with this question for several years; today, in Executive Benefits Insurance Agency v. Arkison, it came a step closer to a common-sense answer.

If you were designing a legal utopia, you would give bankruptcy courts authority over not only the bankruptcy itself but also ordinary legal actions related to the estate. Sadly, in the actual existing U.S., things aren't so simple.

The bankruptcy courts don't have the formal constitutional status of the federal district courts, whose judges are appointed for life. Instead, the bankruptcy courts were created by Congress as a species of adjuncts to the existing district courts; their judges sit for 14 years. Technically, the bankruptcy courts fall under Article I of the Constitution, which enumerates the powers of Congress, not Article III, which governs the judiciary.

Congress tried to split the difference between the utopian model and our decidedly non-utopian Constitution. It divided cases related to bankruptcy into a set of "core" and "non-core" categories. Those in the core could be decided by the bankruptcy courts. For cases outside the core, Congress said the bankruptcy court could issue findings of law and findings of fact, just as though it were deciding the case.

Instead of those findings being final, however, they would be passed on to a federal district court to consider the issue afresh. Although the district court's review would be "de novo," as lawyers like to say in their fancy-but-obvious law Latin, in reality the district court would save a lot of trouble by adopting the findings of the bankruptcy judge.

In 2011, bankruptcy briefly got sexy when the Supreme Court decided the wildly messy tabloid case that grew out of Anna Nicole Smith's brief marriage to 89-year-old Texas mogul J. Howard Marshall. Ultimately decided under the name Stern v. Marshall, the case overturned Congress's core/non-core scheme. The court held that a bankruptcy court lacked the authority to decide some true common-law claims, such as the tort claim that Marshall's son brought against Smith's bankruptcy estate for allegedly defaming him and the counterclaim her estate brought against Marshall's son for tortious interference with the gifts Marshall wanted to give her.

The Stern decision left a hole in bankruptcy law: What should bankruptcy courts do when confronted with similar claims in the future? The bankruptcy statute considered such claims to be "core" claims to be decided finally by the bankruptcy court -- but according to the Supreme Court, the Constitution blocked the bankruptcy court from deciding them.

If you can sense the logical answer in the background, give yourself an A and go to the front of the class. The sensible thing for the courts to do would be to treat all related litigation the way they treat non-core claims related to bankruptcy. The bankruptcy court could issue findings of fact and law, then pass these on to the district court for review.

Yet for reasons known only to itself, the Supreme Court in 2011 didn't actually reach this conclusion. The issue remained unresolved until today, when the court held that -- you guessed it -- the bankruptcy courts should just treat what used to be known as core cases the same way they have been treating non-core cases. The opinion, written by Justice Clarence Thomas, was unanimous.

Why should we care? It's nice when the Supreme Court does something sensible, but it's hardly earth-shattering. Away from the headlines, the court's decisions are often unanimous, and occasionally even reasonable.

Today's bankruptcy decision matters because it shows that there are limits to the extreme formalism that the court has recently adopted in many cases. Just last week, for example, in a pair of patent cases, the court followed the literal reading of the Patent Act at the expense of the federal circuit's policy-driven interpretation. And it had to bend over backward to avoid convicting a woman for a chemical weapons violation when she tried to poison her husband's girlfriend.

The 2011 decision was also an instance of aggressive formalism. Does it really violate the Constitution for bankruptcy courts to decide related cases, but not for them to make findings of law and fact and pass them on to a district court? Maybe -- but it probably makes little difference in practice.

With all this literalism in the air, the court could very well have said that the bankruptcy courts couldn't consider the former core claims at all without a special intervention from Congress. Reality, though, intervened. There are many thousands of bankruptcies before the courts at any given moment. Waiting for Congress would mean a mess in the meantime -- and Congress might well complicate things further if it actually sat down to legislate a fix.

We're still pretty far from legal utopia. But if the district courts use common sense and uphold the bankruptcy courts' decisions, we may at least be approaching the land of common sense.

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