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In Re v. Donald F. Flynn

January 31, 2012

IN RE CHAPTER 7 02 B 22977 EMERALD CASINO, INC.
PLAINTIFF, DEBTOR
FRANCES GECKER, NOT INDIVIDUALLY BUT SOLELY AS CHAPTER 7 TRUSTEE FOR THE BANKRUPTCY ESTATE OF EMERALD CASINO, INC. PLAINTIFF,
v.
DONALD F. FLYNN, KEVIN F. FLYNN, JOHN P. MCMAHON, JOSEPH F. MCQUAID, KEVIN D. LARSON, WALTER P. HANLEY, AND PEER PEDERSEN, DEFENDANTS.
IN RE KEVIN F. FLYNN, JOHN P. MCMAHON, JOSEPH F. MCQUAID, KEVIN D. LARSON, AND WALTER P. HANLEY,
PETITIONERS.



Bankr. Adv. No. 08 A 00972 Hon. Eugene R. Wedoff, Bankruptcy Judge

The opinion of the court was delivered by: Hon. Rebecca R. Pallmeyer

MEMORANDUM ORDER

Bankruptcy Judge Eugene Wedoff is presiding over the Emerald Casino bankruptcy. In response to proofs of claim filed by a number of officers and directors of Emerald Casino, the bankruptcy Trustee, Frances Gecker, filed a variety of counterclaims. Judge Wedoff conducted a lengthy bench trial on those counterclaims in late 2010 and, after several postponements, is scheduled to issue a ruling on Wednesday, February 1, 2012. In consolidated proceedings before this court, the counterclaim Defendants challenge Judge Wedoff's continued exercise of jurisdiction on two grounds: First, in Gecker v. Flynn, No. 11 C 4714, Defendants argue that the Supreme Court's ruling in Stern v. Marshall, 131 S. Ct. 2594 (2011), strips the bankruptcy court of its authority to enter judgment in certain "core proceedings," a term defined to include "counterclaims by the estate against persons filing claims against the estate." 28 U.S.C. § 157 (b)(2)(C). The claims at issue here fall into the category for which the bankruptcy court has no authority to enter judgment, Defendants argue. They contend that this court should therefore withdraw the reference to the bankruptcy court. Second, in McMahon v. Gecker, No. 11 C 7515, Defendants ask the court to require Judge Wedoff to recuse himself from the case for reasons that include the judge's son's recent employment as an associate with Jenner & Block, the law firm that represents the Trustee in this matter.*fn1

For the reasons explained here, the court concludes that Defendants appear to be correct that Judge Wedoff has no power to enter judgment on certain of the Trustee's counterclaims. Although that determination does not require withdrawal of the reference, the court exercises its discretion to do so in this instance. The petition for a writ of mandamus is therefore terminated as moot.

Motion to Withdraw the Reference

The United States Bankruptcy Code authorizes bankruptcy judges to hear and enter final judgments in "all core proceedings arising under title 11, or arising in a case under title 11." 28 U.S.C. §157(b)(1). Among the list of proceedings defined by the statute as "core proceedings" are "counterclaims by [a debtor's] estate against persons filing claims against the estate." 28 U.S.C. §157(b)(2)(C). With respect to "non-core proceedings," on the other hand--that is, proceedings that are merely "otherwise related" to a case under title 11-a bankruptcy judge may not enter a final judgment, but must instead "submit proposed findings of fact and conclusions of law to the district court." 28 U.S.C. § 157(c)(1). The plain language of the Code thus gives Judge Wedoff the authority to enter a final ruling on the Trustee's counterclaims against Defendants in this case, and he conducted a six-week bench trial in November and December 2010. The parties' post-trial briefs followed. Judge Wedoff had not yet ruled on the case when the Supreme Court decided Stern v. Marshall in June of last year.

In Stern, the Supreme Court announced that a bankruptcy court lacks authority under the Constitution to issue a final judgment in a lawsuit arising solely under state common law seeking to bring assets into a debtor's bankruptcy estate. 131 S. Ct. at 2620. The case arose from a bankruptcy proceeding filed by Vickie Lynn Marshall (known to the world as Anna Nicole Smith). Id. at 2601. Pierce Marshall, the son of Ms. Marshall's late husband, filed a proof of claim in her Chapter 11 case, seeking to recover damages for defamation; he claimed Ms. Marshall had falsely accused him of interfering with her expectation of money from her late husband's estate. Id. The trustee in bankruptcy responded by alleging tortious interference as a counterclaim against Pierce in the bankruptcy proceeding; specifically, the trustee asserted a common-law tort claim for intentional interference with a testamentary gift. Id.

In considering whether the bankruptcy court properly entered a judgment against Pierce, the Supreme Court recognized that the Bankruptcy Code characterizes a counterclaim against a party who has filed a proof of claim as a matter of "core" bankruptcy jurisdiction. Id. at 2603 (citing 28 U.S.C. §157(b)(2)(c)). As the Ninth Circuit observed, however, not all such counterclaims are "so closely related to [a creditor's] proof of claim that the resolution of the counterclaim is necessary to resolve the allowance or disallowance of [the creditor's own] claim," Stern, 131 S. Ct. at 2602 (first alteration in original) (quoting In re Marshall, 600 F.3d 1037, 1058 (9th Cir. 2010)). The Court concluded that Ms. Marshall's tortious interference claim was "a state law action independent of the federal bankruptcy law and not necessarily resolvable by a ruling on the creditor's proof of claim in bankruptcy." Id. at 2611. Despite the explicit statutory authority granted to bankruptcy courts in such circumstances, the Court concluded that the bankruptcy judge "lacked the constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof of claim." Id. at 2620.

In the months since the Supreme Court's ruling in Stern, dozens of courts have considered its impact on pending bankruptcy proceedings. Just weeks ago, our Court of Appeals described Stern as holding "that Article III prohibited Congress from giving bankruptcy courts authority to adjudicate claims that went beyond the claims allowance process." In re Ortiz, ___ F.3d ___, 2011 WL 6880651, at *3 (7th Cir. Dec. 30, 2011) (citing Stern, 131 S. Ct. at 2618). In Ortiz, a health care provider had filed proofs of claim in hundreds of individual bankruptcy proceedings. Id. at *1. The debtors brought two class actions against the provider, alleging that the proofs of claim disclosed confidential medical information, in violation of state law. Id. The bankruptcy judge entered judgment against the debtors, and, pre-Stern, the Seventh Circuit had permitted a direct appeal of the judgment orders. Id. at *1-2. In its December 30 opinion, however, the Court of Appeals concluded that Stern required dismissal of those appeals. Although the debtors' claims arose from the bankruptcy procedures, the bankruptcy judge lacked authority to resolve and enter a final judgment on the debtors' counterclaims because the bankruptcy court did not have to decide those counterclaims in the process of ruling on the health care provider's own claims against the bankruptcy estate. Id. at *6.

As the Ortiz court explained, the question in Stern was whether Article III permits the bankruptcy courts to hear and finally decide a particular type of core proceeding. Under § 157(b)(2)(C), "counterclaims by the estate against persons filing claims against the estate" are specifically denominated as core proceedings. The counterclaim at issue in Stern was a state common-law tort claim. 131 S. Ct. at 2601-02. The Court acknowledged that Congress had, in § 157(b)(2)(C), designated this kind of claim as "core," but concluded that Article III did not permit the bankruptcy court to hear and finally decide it. Id. at 2608. That is, Congress could not delegate to a non-Article III court the judicial power "to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof of claim." Id. at 2620.

The application of Stern and its progeny to this case is not completely straightforward. There is no genuine dispute that the Trustee's counterclaims are "core" proceedings; Judge Wedoff so characterized it in several of his scheduling orders, and the Trustee does not effectively argue otherwise. The Trustee suggests, however, that Judge Wedoff may nevertheless have constitutional authority to decide them if those claims are "resolved in the process of ruling on [Defendants'] proofs of claim." (Trustee's Objection to Certain Def.'s Mot. to Withdraw the Reference Pursuant to U.S. Supreme Court Decision on June 23, 2011, in Stern v. Marshall, at 13.) Defendants here have no use for fine distinctions; they urge that Stern, and the Court's earlier decisions in Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989) and Northern Pipeline v. Marathon Pipe Line Co., 458 U.S. 50 (1982) establish that the bankruptcy court has no constitutional authority to enter final judgments in any "traditional action" seeking money damages for tort, breach of contract, or fiduciary duty under state law which merely seeks to "augment the bankruptcy estate." Stern, 131 S. Ct. at 2609, 2614. The Trustee's counterclaim is just such a "traditional action," Defendants urge. Count I is a claim for more than $500 million in compensatory and punitive damages for Defendants' alleged breach of fiduciary duty; Count II is a state law breach of contract claim; Count III seeks disallowance of the Defendants' proofs of claim under 11 U.S.C. § 502(d); Count IV seeks equitable subordination of all these Defendants' proofs of claim on the bases of the same breaches of fiduciary duty and contract alleged in Counts I and II; Count V, against Defendant Donald F. Flynn, asks the court to classify Flynn's pre-petition loans to Emerald as equity rather than debt; and Count VI seeks disallowance of proofs of claim for amounts owed under a settlement agreement.

This court concludes, contrary to Defendants' insistence, that certain of these claims could indeed be resolved in the process of ruling on the proofs of claim. For example, in the course of adjudicating Donald Flynn's proof of claim, the bankruptcy court may conclude that Flynn's loans to Emerald were equity investments, rather than debt obligations. The bankruptcy court would presumably disallow Flynn's proof of claim in that amount and rule in favor of the Trustee on her counterclaim.

That said, this court agrees with Defendants that not all of the counterclaims appear to be amenable to such resolution. In particular, the Trustee's state law claims for breach of contract and breach of fiduciary duty are state law claims to augment the bankruptcy estate. True, in deciding factual issues as part of the claims resolution process, Judge Wedoff will make determinations relevant to the Trustee's counterclaims as well. But that overlap may not be enough to escape the Stern holding; after all, if the trustee in Stern prevailed in her claim of intentional interference, presumably the findings supporting that determination would have defeated Pierce Marshall's defamation claim, as truth is a defense to such a claim. That overlap evidently did not satisfy the Court, which observed, "'Congress may not vest in a non-Article III court the power to adjudicate, render final judgment, and issue binding orders in a traditional contract action arising under state law.'" 131 S. Ct. at 2615 (quoting Thomas v. Union Carbide Agric. Prod. Co., 473 U.S. 568, 584 (1985)). Though the Trustee would prefer to minimize its reach, Stern is indeed "quite significant," Ortiz, 2011 WL 6880651, at *3, in its conclusion that bankruptcy courts lack authority to finally adjudicate claims that go beyond the claims allowance process. The Trustee, of course, has far more experience with the claims allowance process than does this court, but she has not pressed the argument that her counterclaims are unaffected by Stern. For now, the court concludes that Stern precludes Judge Wedoff's entry of a final judgment on any state law counterclaim that would bring assets into the bankruptcy estate.

The question that follows is whether Stern is so significant as to preclude the bankruptcy judge from taking any further action in this case at all. Defendants urge the court to withdraw the reference and insist that the case law requires this result, but the court is less certain. Most significantly, the Supreme Court's opinion does not contemplate withdrawal of the reference in every case where the trustee has asserted counterclaims that the bankruptcy judge may not ...


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