United States District Court, N.D. Illinois, Eastern Division
MEMORANDUM OPINION AND ORDER
AMY J. ST. EVE, District Judge.
Plaintiff Fifth Third Mortgage Company ("Fifth Third") appeals from the December 31, 2014 Order (the "Bankruptcy Order") of the United States Bankruptcy Court for the Northern District of Illinois (the "Bankruptcy Court") finding Defendant Kevin Blouin's ("Blouin") debt to Fifth Third to be non-dischargeable. For the following reasons, the Court vacates the order of the Bankruptcy Court, and remands this case for further proceedings consistent with this Opinion.
Blouin filed a voluntary petition for bankruptcy in the United States Bankruptcy Court for the Northern District of Illinois on May 23, 2014. Petition, In re Blouin, No. 14-BK-19532 (Bankr. N.D.Ill. May 23, 2014). On September 8, 2014, Fifth Third filed an adversary complaint (the "Adversary Complaint") against Blouin for non-dischargeability pursuant to 11 U.S.C. §§ 523(a)(2)(A) and (a)(6). (R. 6-2, Record on Appeal, at 1, 5.) Specifically, Fifth Third alleged that Blouin acted as a mortgage broker in a scheme to defraud mortgage lenders, including Fifth Third, by assisting borrowers in obtaining multiple mortgage loans over a short period of time without disclosing the borrowers' full financial liability to the prospective lenders, and then by closing the loans before the borrowers' credit reports reflected their mortgage obligations. (Id. at 6.) Fifth Third alleged that as a result of Blouin's fraud, it sustained damages in the amount of $278, 303.51,  and requested that the Bankruptcy Court enter a monetary judgment against Blouin and find the debt to be non-dischargeable. (Id. at 11.)
Blouin did not answer or otherwise plead to the Adversary Complaint, and Fifth Third filed a motion for default judgment on December 2, 2014. (Id. at 30.) The motion sought both a monetary judgment against Blouin on Fifth Third's fraud claim, and a determination that the debt was non-dischargeable. (Id. at 32-36.) On December 9, 2014, the Bankruptcy Court held a hearing on Fifth Third's motion. The Bankruptcy Court explained that its normal practice in dischargeability proceedings on an underlying state law claim is to rule on the issue of dischargeability, but not to decide the merits of the claim itself. (R. 8, 12/9/2014 Hearing Tr., at 2-3.) After Blouin stated that he did not contest the non-dischargeability of Fifth Third's fraud claim, the Bankruptcy Court entered an order finding that debt to be non-dischargeable and closed the case without ruling on the merits of the underlying claim. (Id. at 4-5; R. 6-2, Record on Appeal, at 81.) Fifth Third appeals the Bankruptcy Court's decision not to adjudicate its fraud claim against Blouin.
This Court has jurisdiction to review final bankruptcy court decisions. 28 U.S.C. § 158(a)(1); Fed.R.Bankr.P. 8001; 8003. On appeal, a district court reviews a bankruptcy court's factual findings for clear error, and its legal conclusions de novo. See Kovacs v. United States, 739 F.3d 1020, 1023 (7th Cir. 2014); Mungo v. Taylor, 355 F.3d 969, 974 (7th Cir. 2004). If the bankruptcy court correctly states the law, "its determination of whether the facts met the legal standard will be disturbed only if it is clearly erroneous." In re Berman, 629 F.3d 761, 766 (7th Cir. 2011) (citing Pinkston v. Madry, 440 F.3d 879, 888 (7th Cir. 2006)).
On appeal, Fifth Third contests the decision of the Bankruptcy Court not to decide its claim against Blouin and to only find that debt to be non-dischargeable. At the hearing on Fifth Third's motion for default judgment, the Bankruptcy Court declined to enter a monetary judgment against Blouin for two reasons. First, the Bankruptcy Court found that it did not have the constitutional authority to decide Fifth Third's fraud claim based on the Supreme Court's decision in Stern v. Marshall, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011). Second, the Bankruptcy Court found that under existing Seventh Circuit precedent, Blouin did not waive his right to object to the Bankruptcy Court's constitutional authority to hear Fifth Third's fraud claim by failing to answer or otherwise plead to Fifth Third's complaint. Thus, even though the Bankruptcy Court entered a default judgment against Blouin on the issue of dischargeability, it found that Blouin did not consent to the Bankruptcy Court's adjudication of Fifth Third's state law claim against him. Fifth Third appeals both grounds for the Bankruptcy Court's decision, and the Court considers each in turn.
I. Stern v. Marshall
The Court first addresses the issue of the Bankruptcy Court's constitutional authority to decide Fifth Third's fraud claim under Stern v. Marshall, 131 S.Ct. 2594, 180 L.Ed.2d 475. In Stern, the son of the debtor's deceased husband filed a proof of claim against the debtor in her bankruptcy proceeding, alleging that she had defamed the son by inducing her lawyers to tell members of the press that he had engaged in fraud in order to gain control of his deceased father's assets. Id. at 2601, 180 L.Ed.2d 475. He also sought a declaration that his defamation claim was not dischargeable in bankruptcy. Id. In response, the debtor filed a counterclaim for tortious interference against the son for wrongfully preventing her deceased husband from taking the legal steps necessary to provide her with half of his property. Id.
The Supreme Court held that even though the counterclaim was a "core" bankruptcy proceeding under 11 U.S.C. § 157(b)(2)(C) as the debtor brought it against a creditor that had filed a claim against the bankruptcy estate, the bankruptcy court did not have the constitutional authority to adjudicate the claim. Id. at 2604, 2608, 180 L.Ed.2d 475. The Court noted that under Article III of the Constitution, bankruptcy courts generally may not exercise the "judicial Power of the United States" because Congress established them by legislation and bankruptcy court judges do not receive the protections of Article III. Id. at 2611, 2620, 180 L.Ed.2d 475. The Supreme Court then held that the bankruptcy court did not have the power to adjudicate the state law counterclaim at issue because the claim was "independent of the federal bankruptcy law and not necessarily resolvable by a ruling on the creditor's proof of claim in bankruptcy, " and was based on private rights, not public rights that "can be decided outside the Judicial Branch." Id. at 2611, 180 L.Ed.2d 475.
Before Stern, the law in the Seventh Circuit was clear that bankruptcy courts could issue monetary judgments on state law claims in the course of determining their dischargeability. The Seventh Circuit had held that it is "preferable to allow bankruptcy courts ruling on the dischargeability of a debt to adjudicate the issues of liability and damages also." In re Hallahan, 936 F.2d 1496, 1508 (7th Cir. 1991). Since the Supreme Court decided Stern, however, courts have wrestled with the types of state law claims over which bankruptcy courts may constitutionally exercise jurisdiction. With respect to bankruptcy courts deciding underlying state law claims in dischargeability proceedings, the Seventh Circuit recently acknowledged that " Stern limits a bankruptcy court's power to decide a debtor's state-law counterclaim against a creditor when resolving the creditor's proof of claim[, ]...[b]ut it is unclear whether Stern also restricts a bankruptcy court's power to resolve a creditor's state-law claim when the court decides whether that claim is nondischargeable." Lee v. Christenson, 558 F.Appx. 674, 676 (7th Cir. 2014).
While the law in the Seventh Circuit is unsettled, the majority of courts to address this issue have found that bankruptcy courts can constitutionally decide a creditor's claim in the course of deciding its dischargeability. In Adas v. Rutkowski, for example, another recent case in this district, the court found that Stern "does not preclude courts from determining liability in the context of adjudicating the rights of debtors and creditors in the nondischargeability context." Adas v. Rutkowski, No. 13-CV-2517, 2013 WL 6865417, at *9 (N.D. Ill.Dec. 30, 2013) ...