Issue-Specific Withdrawal of the Reference

What Is Withdrawal of the Reference?

Section 157(a) of the Judicial Code (28 U.S.C. ' 101 et seq.) provides the federal district courts with a mechanism for “referring” to bankruptcy courts in their respective districts “any or all cases under title 11 and any or all proceedings arising under title 11 or arising in or related to a case under title 11.” Generally, each district court issues a standing order automatically referring such matters to the bankruptcy court in its district.

However, not all matters are appropriately referred to bankruptcy courts. Limitations on the bankruptcy courts' power to hear and decide controversies were codified as part of the Bankruptcy Amendments and Federal Judgeship Act of 1984 in response to the Supreme Court's decision in Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 485 U.S. 50 (1982). In Marathon, the Supreme Court (in a plurality decision) held that the attempt under the Bankruptcy Reform Act of 1978 to vest bankruptcy judges with broad jurisdictional powers was unconstitutional, as bankruptcy judges do not have the life tenure or protection against salary diminution guaranteed to Article III judges. Thus, the non-Article III bankruptcy courts could only be vested with the ability to adjudicate matters “involving public rights,” i.e., matters involving the government or a governmental scheme, and not state-created private rights, such as state law claims of breach of contract or warranty. Marathon Pipeline, 458 U.S. at 71. In response to Marathon, Section 157(b)(2) sets forth a non-exclusive list of “core” matters over which bankruptcy courts have historically exercised jurisdiction to issue orders and judgments. Section 157(c), in turn, provides that for non-core “related-to” matters, a bankruptcy judge may hear and render proposed findings of fact and conclusions of law to the district court for de novo review, but may not finally determine or issue orders or judgments without the consent of the parties.

Finally, Section 157(d) prescribes where the district courts may ' or must ' “withdraw the reference” and hear the case or proceeding directly. First, the district court may withdraw any case or proceeding “for cause shown.” Such a withdrawal is “permissive.” Cause is not defined, but courts weigh “whether the claim or proceeding is core or non-core, whether it is legal or equitable, and considerations of efficiency, prevention of forum shopping, and uniformity in the administration of bankruptcy law.” Orion Pictures Corp. v. Showtime Networks Inc. (In re Orion Pictures Corp.), 4 F.3d 1095, 1101 (2d Cir. 1993). Withdrawal is mandatory, however, “if the court determines that resolution of the proceeding requires consideration of both title 11 and other laws of the United States regulating organizations or activities affecting interstate commerce.” 28 U.S.C. ' 157(d). In short, if the court is going to be asked to determine substantial and material issues arising under federal non-bankruptcy statutes, the reference must be withdrawn.

What Can Be Withdrawn?

Section 157(d) provides for withdrawal “in whole or in part” of any case or proceeding. The scope of “ in part” is unclear. The 1984 Act has scant meaningful legislative history; there is no separate report accompanying the bill, and the individual remarks shed little light. The Emergency Interim Rule in place following Marathon and prior to the effectiveness of the 1984 amendments provides no greater clarity, having given the district court discretion to retain withdrawn matters, or to refer them back to the bankruptcy court in part, or in whole, with instructions for proceeding.

Courts historically have interpreted the statute in a number of different ways. They regularly permit the withdrawal of particular counts or claims. See, e.g., Mirant Corp. v. The Southern Company, 337 B.R. 107 (N.D. Texas 2006) (withdrawing the reference with respect to non-core claims); In re The Babcock & Wilcox Co., 2000 U.S. Dist. LEXIS 5626 (E.D. La. April 17, 2000) (partially withdrawing the reference with respect to asbestos personal injury claims). In other cases, the district court withdrew the reference only for trial, leaving all discovery and motion practice to the bankruptcy court. See, e.g., Rice v. Luke Communications, LLC, 2011 U.S. Dist. LEXIS 14222 (E.D. Ark. Feb. 3, 2011) (delegating pre-trial coordination to bankruptcy court). Less frequently, courts may withdraw particular issues within a controversy. See, e.g., Barona Group of the Capitan Grande Band of Mission Indians v. American Management & Amusement, Inc., 840 F.2d 1394 (9th Cir. 1987) (reference withdrawn to determine validity of management agreement in breach of contract action); see also Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, Adv. Pro. No 08-01789, 12 MC 0115 (S.D.N.Y. April 13, 2012); Picard v. Avellino, 2012 U.S. Dist. LEXIS 35260 (S.D.N.Y. March 1, 2012); Picard v. Flinn Invs, LLC, 463 B.R. 280 (S.D.N.Y. 2011) (discussed below).

Appealing the Withdrawal of the Reference

Orders withdrawing the reference are interlocutory, and several circuit courts have held that they are unreviewable under 28 U.S.C. ' 1291 until after a final order has been entered. See, e.g., Lieb v. Thomson (In re Lieb), 915 F.2d 180, 184 (5th Cir. 1990) (citing decisions in the Second, Third, Seventh, Ninth, Tenth and Eleventh Circuits), reh'g denied, 1990 U.S. App. LEXIS 21898 (5th Cir., Dec. 13, 1990). However, the Supreme Court has held that 28 U.S.C. ' 1292(b) enables circuit courts to hear appeals of interlocutory bankruptcy orders where the district judge states in writing that the matter “involves a controlling question of law as to which there is substantial ground for difference of opinion and that an immediate appeal ' may materially advance the ultimate termination of the litigation.” See Connecticut National Bank v. Germain, 503 U.S. 249 (1992); see also 1-3 Collier on Bankruptcy at ' 3.04 (Matthew Bender & Co. 2012). Moreover, at least two circuit courts have granted mandamus review where the district court, acting sua sponte, failed to show cause for withdrawing the reference. See Canter v. Canter (In re Canter), 299 F.3d 1150, 1154-55 (9th Cir. 2002); In re Pruitt, 910 F.2d 1160, 1165 (3d Cir. 1990). Both Canter and Pruitt acknowledge that withdrawal orders are interlocutory and generally unappealable absent extraordinary circumstances. Clearly, immediate review of orders determining withdrawal of the reference motions is the exception rather than the rule.

The Impact of Stern v. Marshall

Historically, courts treated withdrawal of the reference as not mandatory for any “core” matter pursuant to 28 U.S.C. ' 157(b). The Supreme Court's ruling in Stern v. Marshall, 564 U.S. ___, 131 S. Ct. 2594 (2011) compelled a reexamination of that treatment.

In Stern, the Supreme Court held that the conferral of authority on the bankruptcy court under 28 U.S.C.
' 157(b) to determine the debtor's state law counterclaim was unconstitutional. Following its holdings in Marathon and Granfinanciera S.A. v. Nordberg, 492 U.S. 33 (1989) (where the Court held that a fraudulent conveyance action against a non-creditor did not fall within the “public rights” exception), the Court held the counterclaim to be a private claim, not subject to the “public rights” exception. Plaintiff's proof of claim, which asserted a defamation claim, did not alter that result since it was wholly unrelated to the debtor's counterclaim. Absent consent of the parties, bankruptcy courts lack the constitutional authority to enter final judgment on such state law counterclaims.

Fallout from Stern v. Marshall: Increased
Withdrawal of Discrete Issues?

Much has been written about the uncertainty raised by Stern v. Marshall and the administrative inefficiencies it will cause. Bankruptcy and district courts are already treading carefully in Stern's wake. See, e.g., Kirschner v. Agoglia, 11 Civ. 8250 (S.D.N.Y. Opinion and Order dated May 9, 2012) (although the bankruptcy court lacked constitutional authority to issue a final order on a motion to dismiss core fraudulent conveyance claims, it could issue a report and recommendation subject to the district court's de novo review); Schwartz v. Deutsche Bank National Trust Co. (In re Schwartz), 2011 U.S. Dist LEXIS 144470, *2 (D. Mass. Dec. 15, 2011) (the district court withdrew the reference “to ensure that the adversary proceeding conforms with the constitutional requirements elucidated in Stern v. Marshall“); Federal Insurance Co. v. DBSI, Inc. (In re DBSI, Inc.), 2011 Bankr. LEXIS 2727, (Bankr. D. Del. July 22, 2011) (the bankruptcy court declined to rule on a motion for summary judgment, instead inviting the parties to file written submissions on whether Stern v. Marshall permitted it to do so). Many district courts have issued amended standing orders of reference providing for bankruptcy judges to submit proposed findings of fact and conclusions of law to the district on “core” matters where there may be a Constitutional question as to the bankruptcy judge's authority to enter a final order or judgment. See, e.g., In re Standing Order of Reference Re: Title 11, 12 Misc. 32 (S.D.N.Y. Feb. 1, 2012) (C.J. Preska).

Litigants have capitalized on the courts' collective hesitation by filing motions to withdraw the reference in droves. Nevertheless, while Stern may have directly led to the recent deluge of such motions, the results may be narrowly limited in scope. Courts have increasingly limited the withdrawal to a specific issue or issues, such as the bankruptcy court's jurisdiction and ability to issue proposed findings and conclusions in “core” matters.

The district court presiding over hundreds of withdrawal of the reference motions by fraudulent transfer defendants in the Madoff proceedings has taken precisely that approach. Judge Rakoff has issued several orders withdrawing the reference to the bankruptcy court to determine how Stern impacts the bankruptcy court's ability to render decisions and/or to propose findings of fact and conclusions of law, as well as to address issues requiring significant interpretation of securities and other federal law. See, e.g., Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, Adv. Pro. No 08-01789, 12 MC 0115 (S.D.N.Y. April 13, 2012); Picard v. Avellino, 2012 U.S. Dist. LEXIS 35260 (S.D.N.Y. March 1, 2012); Picard v. Flinn Invs, LLC, 463 B.R. 280 (S.D.N.Y. 2011).

However, not all post-Stern efforts to withdraw the reference have been successful. Judge Denise Cote of the Southern District of New York denied without prejudice two motions to withdraw the reference to the bankruptcy court in fraudulent transfer litigation arising out of the Lyondell bankruptcy. While acknowledging that the bankruptcy court did not have authority to issue a ruling on the pending fraudulent transfer claims, Judge Cote noted that at the present time, efficiency dictated that the cases remain before the bankruptcy court, which had presided over pretrial proceedings, including discovery and motion practice. See Opinion and Order, 11 Civ. 8251, 11 Civ. 8445 (S.D.N.Y. March 29, 2012).

Conclusion

While it may be efficient to address threshold issues at the outset, the propriety of issue-based withdrawals of the reference is unclear, given the lack of clarity as to what withdrawal “in part” means. The general unavailability of interlocutory appeals will hamper any effort to test the district court's ability to exercise withdrawal on an issue-by-issue basis. It will be interesting to see whether the trend of issue-based withdrawals continues, and whether motions to withdraw the reference become a staple of defendants' tactics in bankruptcy litigation.

Menachem (Mendy) Zelmanovitz is a partner in the Finance and Restructuring Group of Morgan, Lewis & Bockius LLP, resident in New York. Rachel Jaffe Mauceri is an associate in the Finance and Restructuring Group, resident in both New York and Philadelphia. They may be reached at [email protected] and [email protected] respectively.

Traditionally, defendants in actions brought by debtors or trustees have struggled to level the playing field and extricate themselves from the bankruptcy court, a forum often perceived as the plaintiff's “home court.” At one time, litigants hoped to utilize motions to withdraw the reference from the bankruptcy court pursuant to 28 U.S.C. ' 157(d), to enhance their prospects of a favorable resolution from a presumably friendlier judicial forum. However, more often than not, movants were disappointed by the district courts' natural reluctance to relieve the bankruptcy courts of their intended role and increase their own considerable workloads.

The Supreme Court's recent ruling in Stern v. Marshall has revitalized this litigation tactic and encouraged a veritable torrent of such motions. In In re Bernard L. Madoff Investment Securities LLC (Madoff) alone, a liquidation proceeding under the Securities Investor Protection Act currently pending before the Bankruptcy Court for the Southern District of New York, literally hundreds of such motions have been filed in the fraudulent transfer actions commenced by the trustee. District Judge Jed S. Rakoff has issued several orders withdrawing the reference, not with respect to the adversary proceedings in their entirety, and not even with respect to individual claims, but with respect to discrete issues underlying those claims (including the effect of Stern v. Marshall on the bankruptcy court's ability to hear and adjudicate avoidance claims).

This article considers the genesis, tendency and scope of the district courts' withdrawals of the reference in some of the more complex proceedings pending today.

What Is Withdrawal of the Reference?

Section 157(a) of the Judicial Code (28 U.S.C. ' 101 et seq.) provides the federal district courts with a mechanism for “referring” to bankruptcy courts in their respective districts “any or all cases under title 11 and any or all proceedings arising under title 11 or arising in or related to a case under title 11.” Generally, each district court issues a standing order automatically referring such matters to the bankruptcy court in its district.

However, not all matters are appropriately referred to bankruptcy courts. Limitations on the bankruptcy courts' power to hear and decide controversies were codified as part of the Bankruptcy Amendments and Federal Judgeship Act of 1984 in response to the Supreme Court's decision in Northern Pipeline Construction Co. v. Marathon Pipe Line Co. , 485 U.S. 50 (1982). In Marathon, the Supreme Court (in a plurality decision) held that the attempt under the Bankruptcy Reform Act of 1978 to vest bankruptcy judges with broad jurisdictional powers was unconstitutional, as bankruptcy judges do not have the life tenure or protection against salary diminution guaranteed to Article III judges. Thus, the non-Article III bankruptcy courts could only be vested with the ability to adjudicate matters “involving public rights,” i.e., matters involving the government or a governmental scheme, and not state-created private rights, such as state law claims of breach of contract or warranty. Marathon Pipeline, 458 U.S. at 71. In response to Marathon, Section 157(b)(2) sets forth a non-exclusive list of “core” matters over which bankruptcy courts have historically exercised jurisdiction to issue orders and judgments. Section 157(c), in turn, provides that for non-core “related-to” matters, a bankruptcy judge may hear and render proposed findings of fact and conclusions of law to the district court for de novo review, but may not finally determine or issue orders or judgments without the consent of the parties.

Finally, Section 157(d) prescribes where the district courts may ' or must ' “withdraw the reference” and hear the case or proceeding directly. First, the district court may withdraw any case or proceeding “for cause shown.” Such a withdrawal is “permissive.” Cause is not defined, but courts weigh “whether the claim or proceeding is core or non-core, whether it is legal or equitable, and considerations of efficiency, prevention of forum shopping, and uniformity in the administration of bankruptcy law.” Orion Pictures Corp. v. Showtime Networks Inc . ( In re Orion Pictures Corp. ), 4 F.3d 1095, 1101 (2d Cir. 1993). Withdrawal is mandatory, however, “if the court determines that resolution of the proceeding requires consideration of both title 11 and other laws of the United States regulating organizations or activities affecting interstate commerce.” 28 U.S.C. ' 157(d). In short, if the court is going to be asked to determine substantial and material issues arising under federal non-bankruptcy statutes, the reference must be withdrawn.

What Can Be Withdrawn?

Section 157(d) provides for withdrawal “in whole or in part” of any case or proceeding. The scope of “ in part” is unclear. The 1984 Act has scant meaningful legislative history; there is no separate report accompanying the bill, and the individual remarks shed little light. The Emergency Interim Rule in place following Marathon and prior to the effectiveness of the 1984 amendments provides no greater clarity, having given the district court discretion to retain withdrawn matters, or to refer them back to the bankruptcy court in part, or in whole, with instructions for proceeding.

Courts historically have interpreted the statute in a number of different ways. They regularly permit the withdrawal of particular counts or claims. See, e.g., Mirant Corp. v. The Southern Company , 337 B.R. 107 (N.D. Texas 2006) (withdrawing the reference with respect to non-core claims); In re The Babcock & Wilcox Co., 2000 U.S. Dist. LEXIS 5626 (E.D. La. April 17, 2000) (partially withdrawing the reference with respect to asbestos personal injury claims). In other cases, the district court withdrew the reference only for trial, leaving all discovery and motion practice to the bankruptcy court. See, e.g., Rice v. Luke Communications, LLC, 2011 U.S. Dist. LEXIS 14222 (E.D. Ark. Feb. 3, 2011) (delegating pre-trial coordination to bankruptcy court). Less frequently, courts may withdraw particular issues within a controversy. See, e.g., Barona Group of the Capitan Grande Band of Mission Indians v. American Management & Amusement, Inc. , 840 F.2d 1394 (9th Cir. 1987) (reference withdrawn to determine validity of management agreement in breach of contract action); see also Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, Adv. Pro. No 08-01789, 12 MC 0115 (S.D.N.Y. April 13, 2012); Picard v. Avellino, 2012 U.S. Dist. LEXIS 35260 (S.D.N.Y. March 1, 2012); Picard v. Flinn Invs, LLC , 463 B.R. 280 (S.D.N.Y. 2011) (discussed below).

Appealing the Withdrawal of the Reference

Orders withdrawing the reference are interlocutory, and several circuit courts have held that they are unreviewable under 28 U.S.C. ' 1291 until after a final order has been entered. See, e.g., Lieb v. Thomson (In re Lieb), 915 F.2d 180, 184 (5th Cir. 1990) (citing decisions in the Second, Third, Seventh, Ninth, Tenth and Eleventh Circuits), reh'g denied, 1990 U.S. App. LEXIS 21898 (5th Cir., Dec. 13, 1990). However, the Supreme Court has held that 28 U.S.C. ' 1292(b) enables circuit courts to hear appeals of interlocutory bankruptcy orders where the district judge states in writing that the matter “involves a controlling question of law as to which there is substantial ground for difference of opinion and that an immediate appeal ' may materially advance the ultimate termination of the litigation.” See Connecticut National Bank v. Germain , 503 U.S. 249 (1992); see also 1-3 Collier on Bankruptcy at ' 3.04 (Matthew Bender & Co. 2012). Moreover, at least two circuit courts have granted mandamus review where the district court, acting sua sponte, failed to show cause for withdrawing the reference. See Canter v. Canter (In re Canter), 299 F.3d 1150, 1154-55 (9th Cir. 2002); In re Pruitt, 910 F.2d 1160, 1165 (3d Cir. 1990). Both Canter and Pruitt acknowledge that withdrawal orders are interlocutory and generally unappealable absent extraordinary circumstances. Clearly, immediate review of orders determining withdrawal of the reference motions is the exception rather than the rule.

The Impact of Stern v. Marshall

Historically, courts treated withdrawal of the reference as not mandatory for any “core” matter pursuant to 28 U.S.C. ' 157(b). The Supreme Court's ruling in Stern v. Marshall , 564 U.S. ___, 131 S. Ct. 2594 (2011) compelled a reexamination of that treatment.

In Stern, the Supreme Court held that the conferral of authority on the bankruptcy court under 28 U.S.C.
' 157(b) to determine the debtor's state law counterclaim was unconstitutional. Following its holdings in Marathon and Granfinanciera S.A. v. Nordberg , 492 U.S. 33 (1989) (where the Court held that a fraudulent conveyance action against a non-creditor did not fall within the “public rights” exception), the Court held the counterclaim to be a private claim, not subject to the “public rights” exception. Plaintiff's proof of claim, which asserted a defamation claim, did not alter that result since it was wholly unrelated to the debtor's counterclaim. Absent consent of the parties, bankruptcy courts lack the constitutional authority to enter final judgment on such state law counterclaims.

Fallout from Stern v. Marshall: Increased
Withdrawal of Discrete Issues?

Much has been written about the uncertainty raised by Stern v. Marshall and the administrative inefficiencies it will cause. Bankruptcy and district courts are already treading carefully in Stern's wake. See, e.g., Kirschner v. Agoglia, 11 Civ. 8250 (S.D.N.Y. Opinion and Order dated May 9, 2012) (although the bankruptcy court lacked constitutional authority to issue a final order on a motion to dismiss core fraudulent conveyance claims, it could issue a report and recommendation subject to the district court's de novo review); Schwartz v. Deutsche Bank National Trust Co. (In re Schwartz), 2011 U.S. Dist LEXIS 144470, *2 (D. Mass. Dec. 15, 2011) (the district court withdrew the reference “to ensure that the adversary proceeding conforms with the constitutional requirements elucidated in Stern v. Marshall“); Federal Insurance Co. v. DBSI, Inc. (In re DBSI, Inc.), 2011 Bankr. LEXIS 2727, (Bankr. D. Del. July 22, 2011) (the bankruptcy court declined to rule on a motion for summary judgment, instead inviting the parties to file written submissions on whether Stern v. Marshall permitted it to do so). Many district courts have issued amended standing orders of reference providing for bankruptcy judges to submit proposed findings of fact and conclusions of law to the district on “core” matters where there may be a Constitutional question as to the bankruptcy judge's authority to enter a final order or judgment. See, e.g., In re Standing Order of Reference Re: Title 11, 12 Misc. 32 (S.D.N.Y. Feb. 1, 2012) (C.J. Preska).

Litigants have capitalized on the courts' collective hesitation by filing motions to withdraw the reference in droves. Nevertheless, while Stern may have directly led to the recent deluge of such motions, the results may be narrowly limited in scope. Courts have increasingly limited the withdrawal to a specific issue or issues, such as the bankruptcy court's jurisdiction and ability to issue proposed findings and conclusions in “core” matters.

The district court presiding over hundreds of withdrawal of the reference motions by fraudulent transfer defendants in the Madoff proceedings has taken precisely that approach. Judge Rakoff has issued several orders withdrawing the reference to the bankruptcy court to determine how Stern impacts the bankruptcy court's ability to render decisions and/or to propose findings of fact and conclusions of law, as well as to address issues requiring significant interpretation of securities and other federal law. See, e.g., Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, Adv. Pro. No 08-01789, 12 MC 0115 (S.D.N.Y. April 13, 2012); Picard v. Avellino, 2012 U.S. Dist. LEXIS 35260 (S.D.N.Y. March 1, 2012); Picard v. Flinn Invs, LLC , 463 B.R. 280 (S.D.N.Y. 2011).

However, not all post-Stern efforts to withdraw the reference have been successful. Judge Denise Cote of the Southern District of New York denied without prejudice two motions to withdraw the reference to the bankruptcy court in fraudulent transfer litigation arising out of the Lyondell bankruptcy. While acknowledging that the bankruptcy court did not have authority to issue a ruling on the pending fraudulent transfer claims, Judge Cote noted that at the present time, efficiency dictated that the cases remain before the bankruptcy court, which had presided over pretrial proceedings, including discovery and motion practice. See Opinion and Order, 11 Civ. 8251, 11 Civ. 8445 (S.D.N.Y. March 29, 2012).

Conclusion

While it may be efficient to address threshold issues at the outset, the propriety of issue-based withdrawals of the reference is unclear, given the lack of clarity as to what withdrawal “in part” means. The general unavailability of interlocutory appeals will hamper any effort to test the district court's ability to exercise withdrawal on an issue-by-issue basis. It will be interesting to see whether the trend of issue-based withdrawals continues, and whether motions to withdraw the reference become a staple of defendants' tactics in bankruptcy litigation.

Menachem (Mendy) Zelmanovitz is a partner in the Finance and Restructuring Group of Morgan, Lewis & Bockius LLP, resident in New York. Rachel Jaffe Mauceri is an associate in the Finance and Restructuring Group, resident in both New York and Philadelphia. They may be reached at [email protected] and [email protected] respectively.