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Back to the Future: Appeals Court Lets Bankruptcy Court Decide State Law Claims

On August 8, 2013, the United States Court of Appeals for the Fifth Circuit in Tanguy v. West (In re Davis) explicitly rejected the argument that the United States Supreme Court decision in Stern v. Marshall posed a bar to the bankruptcy court’s power to enter a final judgment on state law claims, where the original cause of action was brought by a chapter 7 trustee against an obligor on a promissory note to the debtor and the obligor on that note filed state-law counterclaims for breach of warranty and tortious interference by the trustee. In Stern, the Supreme Court held that, under Article III of the Constitution, a bankruptcy court, which is an Article I court, lacks Constitutional power to decide state-law counterclaims asserted by the bankruptcy estate against a creditor unless that counterclaim is necessarily resolved in connection with resolving the creditor’s prepetition claim against the debtor. Applying Stern narrowly, the Fifth Circuit declined to apply Stern to the case at hand because the counterclaims at issue arose postpetition based on alleged misconduct by the chapter 7 trustee in the administration of the estate and thus, unlike Stern, were not the estate’s counterclaims against a party that had filed a proof of claim. The Fifth Circuit emphasized that the Stern decision, by its own terms, should be applied narrowly. However, the trustee’s original claim, like the counterclaim at issue in Stern, was based on state law and does not appear to have been necessarily resolved by a ruling on the defendant’s claims. Nevertheless, at least in the Fifth Circuit, it appears that Stern does not prevent a bankruptcy court from entering a final judgment on a state law action as long as that action is raised by the bankruptcy estate as an original claim rather than as a counterclaim.

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