Bankruptcy's gray area: are bankruptcy courts 'courts of the United States'?

Author:Labate, Angelo G.
 
FREE EXCERPT

INTRODUCTION

To declare bankruptcy throughout much of Anglo-American history was akin to declaring oneself a failure. (1) Bankruptcy, therefore, for much of American history carried a heavy social stigma and was usually reserved for those willing to take on the economic shame that came with debt reorganization. (2) By the 1960s, however, evolving social norms surrounding the abstract ideas of wealth, effort, and success began to erode the negative stigmatization of debt and bankruptcy. (3) Declaring bankruptcy is a common practice today that affects (or will affect) millions of Americans--and the impact of the increased filings are felt strongly in the United States Bankruptcy Courts. As more individuals and corporations turn to the bankruptcy courts to resolve common economic problems, ensuring the system remains effective and efficient is of paramount importance.

National scandals, such as the massive failures of Enron and Lehman Brothers, (4) might paint a picture that bankruptcy is a corporate tool to restructure bad debt and escape what is owed, yet the vast majority of bankruptcy filings are personal. (5) Financial stressors such as high student-loan debts, mortgages, or credit card bills can lead many American families down the road to insolvency. (6) The debt accrued by necessary medical procedures has become the leading cause of personal bankruptcies in the United States. (7) Bankruptcy, therefore, is not only an escape valve for corporations and wealthy individuals, but also a part of the economic reality within our nation for all classes of society.

That is not to say that corporate bankruptcies do not occur regularly, nor does it suggest that they are bad for the economy. In fact, many economists hail the modern bankruptcy system for allowing corporations to restructure soundly, prevent layoffs, and better manage assets to emerge from debt. (8) Therefore, because corporations and the average American family both rely on this system, its efficiency and effectiveness are vital to our modern national economic reality.

Congress, recognizing the importance of commercial and individual bankruptcy matters to the national economy, created a separate court within the federal system to ensure the efficient adjudication of bankruptcy cases. Initially, Congress intended to grant original jurisdiction over all bankruptcy cases to a specialized court--similar to how the Federal Circuit operates today. (9) However, the Supreme Court struck down parts of the 1978 Bankruptcy Act in Northern Pipeline, making many of the reforms inoperative. (10) Congress responded by passing a new law creating an Article I bankruptcy court as a unit within the United States District Courts that would receive cases by referral. (11) The judges of the new bankruptcy court would be deemed "judicial officers" of the district court. (12) Congress, in response to the Supreme Court's decision in Northern Pipeline, did not scrap the bankruptcy court entirely, but instead found a legislative fix--thus showing its commitment to the efficient running of bankruptcy matters within the federal system.

The reforms, in light of the Supreme Court declaring much of the 1978 Bankruptcy Act unconstitutional, created one issue that threatens the efficient running of the system--and therefore the entire purpose of the reforms. The newly created bankruptcy courts were deemed to be a "unit of the district court[s]" of the United States. (13) Thus, the bankruptcy courts began to operate in a gray area. They were neither a stand-alone court nor fully a district court. The nebulous status of the bankruptcy courts is not just a matter of theoretical interest; it a matter of great practical concern. This concern arises due to Congress's repeated use of the phrase "courts of the United States" throughout the United States Code, and the inconsistent treatment of the bankruptcy courts with respect to the phrase. (14) Thus, determining whether the bankruptcy courts are "courts of the United States" has practical import, as inconsistent treatment threatens the integrity and efficiency of the federal bankruptcy system.

The Supreme Court has never directly taken up the issue, but the United States Courts of Appeals have attempted to define the status of the bankruptcy courts for the past several decades. (15) In particular, the circuit courts have taken three approaches to this question: (1) explicitly holding that the bankruptcy courts are not "courts of the United States"; (2) implicitly treating the bankruptcy courts as falling within the definition while not explicitly deciding the issue; or (3) explicitly holding that the bankruptcy courts are "courts of the United States." (16) The resulting circuit split has created a dual status within the federal system for bankruptcy courts, thus jeopardizing not only the efficiency of the courts but also their legitimacy. A slim majority of circuit courts counts the bankruptcy courts as "courts of the United States," (17) while the minority does not grant this status. (18) The practical effect is that in some circuits certain statutes are applicable within a bankruptcy proceeding, whereas in other circuits these same statutes would be inapplicable to the same case. Depending on the circuit, statutory procedural tools such as sanctions, fee shifting, and declaratory judgments might not be available to bankruptcy judges, which jeopardizes their ability to effectively manage a growing docket of bankruptcy matters. As the current system was created to efficiently handle the nation's bankruptcy cases, this status quo is untenable.

This Note seeks to evaluate the circuit split regarding the status of bankruptcy courts and propose a solution to the problem through an efficiency-based lens. Part I lays out a brief history of bankruptcy in the United States and the current bankruptcy system. Part II then outlines the circuit split within the courts of appeals as to the proper definition of "courts of the United States." Part III will analyze the statutory language, the United States Code, and the relevant historical context to determine if the bankruptcy courts qualify as "courts of the United States." This Part argues that the bankruptcy courts are "courts of the United States." Part IV will discuss, from an efficiency-based lens, the policy rationale supporting this legal conclusion. The Note concludes by suggesting that Congress or the Supreme Court should intervene and legitimize the bankruptcy courts as "courts of the United States." This conclusion is reached by analyzing the United States Code in a consistent and uniform manner with common tools of statutory interpretation--with attention paid to history, Congressional purpose, and general principles of efficiency.

  1. A BRIEF HISTORY' OF THE US BANKRUPTCY SYSTEM

    To better understand how the current bankruptcy court operates within the overall federal system, and just what Congress could have meant by its repeated use of the phrase "courts of the United States," it is important to look at the evolution of the bankruptcy system. By tracing the changes to the bankruptcy system over time, through an efficiency-based lens, past inadequacies can be gleaned. Analysis of these inadequacies will help illuminate a solution to the disagreement underlying the ongoing circuit split surrounding the status of the bankruptcy courts.

    1. Bankruptcy in the Founding Era

      The framers of the Constitution recognized the importance of bankruptcy when they granted Congress the power to "establish ... uniform Laws on the subject of Bankruptcies throughout the United States." (19) The inclusion of the Bankruptcy Clause within the powers of Congress was part of a greater attempt to federalize the economy in the wake of the failure of the Articles of Confederation. (20) The Federalist Papers also defended a uniform federal bankruptcy power as being necessary for the economic health of the new republic. (21) The appearance of the bankruptcy power among the more general commerce powers highlights that the Founders saw not only how important the power was to the emerging economy, but also how potentially dangerous discriminatory and differing state laws could be. (22) With little debate, and only one vote against, the clause was added to the Constitution--yet Congress chose not to exercise this power immediately. (23)

      Over a decade after ratification, Congress would pass the first of many federal bankruptcy laws--the Bankruptcy Act of 1800. (24) Based heavily on English norms, (25) the first act was creditor-friendly and had no provision for individual debtors to file on their own. (26) Procedurally the act carried over the English practice of using commissioners to handle the bankruptcy matters, who would then report to the district courts. (27) By 1803, however, the shortcomings of the law led to its total repeal, leaving bankruptcy law to the regulation of the various state legislatures. (28)

    2. From the New Republic to Civil War

      From the repeal of the Bankruptcy Act of 1800 until 1841, Congress did not attempt to involve itself in the administration of bankruptcy law. The Supreme Court, however, throughout this four-decade interlude routinely hindered the powers of the states effectively to administer bankruptcy proceedings. (29) In the ensuing years the nation experienced periods of severe economic hardship, and the states alone, in the absence of federal bankruptcy law, could not adequately handle the economic crises. (30) Thus, in the early republic, bankruptcy law was neither effective nor uniform, betraying the Founders' earlier intentions.

      In the next several decades, Congress began to exercise its bankruptcy power, but only intermittently in times of economic hardship for the nation. In 1841, in a late response to the Panics of 1837 and 1839, Congress passed a short-lived federal bankruptcy law, which finally allowed for debtors to petition voluntarily for debt relief. (31) Commissioners would again play a...

To continue reading

FREE SIGN UP