Anna Nicole Smith Limits Power of Bankruptcy Judges

Anna Nicole Smith, the deceased public personality, recently had her second encounter with the United States Supreme Court. Vickie Lynn Marshall, known to the public as Anna Nicole Smith filed for bankruptcy after the death of her husband. Howard Marshall II, her late husband’s son, filed suit against Vickie alleging defamation. Vickie counter-sued alleging tortious interference with a gift; asserting that Howard II fraudulently prevented Vickie’s husband from putting Vickie in her husband’s will. The bankruptcy court found in favor of Vickie and awarded her $425 Million Dollars in actual and punitive damages. The case then went through the appeals process and landed in the Supreme Court.

While the case was factually dynamic, the legal issue involved was fairly basic. The issue for the Court was whether Congress could delegate to bankruptcy judges the authority to decide this state court counter-claim. Article III of the United States Constitution gives the Courts the authority to exercise the federal government’s judicial power. Under the principle of Separation of Powers, that authority can not be limited or altered by Congress or the President. Vesting judicial power in the Supreme Court and then permitting either Congress or the President to remove or diminish that power would render the grant of that power meaningless.

Under Article III, Congress has the authority to establish Courts other than the Supreme Court. However, the Judges in these Courts must be appointed during good behavior and be compensated in an amount that may not be diminished during their appointment. Therefore, there are two characteristics of a lower court judge which must be satisfied to make the grant of power to those judges proper. First, the judges must have “tenure”. In other words, they must be appointed for life. This characteristic is not present in bankruptcy court judges. Bankruptcy judges are appointed for 14 year terms. The second characteristic is that the judge’s pay can not be diminished during their lifetime. Bankruptcy judges’ compensation is subject to change by Congress.

There is a “public rights” exception that permits a non-article III judge to exercise the judicial power of the United States. This exception generally focuses on whether the exercise of the power is done so pursuant to a regulatory scheme or whether there is a public, rather than purely private, interest in the subject matter of the suit. Since this case was purely private litigation based on a state law claim, the Judge deciding the matter must have the ability to exercise the judicial power of the United States under Article III of the United States Constitution.

The problem with the Court’s decision was explained by Justice Breyer. Many bankruptcy cases involve compulsory counterclaims. These counter-claims can not be decided by the bankruptcy judge. Now, presumably, litigants will remove these cases from the bankruptcy court and have them decided by the United States District Court. There were 1.5 million bankruptcy filings last year in the United States; compared to roughly 375,000 civil and cases in the District Courts. The potential to overburden the District Court system is great. Additionally, we will likely see more District Court Judges making bankruptcy determinations. Bankruptcy judges have much more expertise in handling these bankruptcy issues.

The interesting question remains whether the United States Supreme Court will further restrict the bankruptcy judge’s ability to perform functions normally thought to be within the purview of the bankruptcy court. Not surprisingly, bankruptcy judges make determinations and orders that are an exercise of judicial power. The potential to restrict that authority is a disturbing idea to anyone involved in the bankruptcy process.

This decision is potentially a serious issue in “lien strip” cases. “Lien Strip” cases are bankruptcy filings where the debtor seeks to avoid (or “strip”) a junior mortgage and treat it as an unsecured obligation. This result is possible when the value of the debtor’s residence is less than the superior mortgage. These types of cases have increased dramatically since the down-turn in housing values.

After this Supreme Court decision, it is unclear whether the Judgments in those cases are binding. On the one hand, the Judgment is a statement of whether the obligation is a secured obligation under the bankruptcy code. On the other, the Judgment is an exercise of judicial authority that this case seems to prohibit.

Anna Nicole Smith’s second trip to the United States Supreme Court resulted in what at first blush is a minor decision regarding the authority of bankruptcy judges. The decision may have been made by the Court to reach what it determined was the proper equities in the case. However, the reasoning in the decision may have a sweeping effect in bankruptcy process. The issue of the current authority of bankruptcy judges is likely to be an issue of litigation for some time to come.