Anna Nicole Smith’s biggest legacy? Confusion in bankruptcy case

October 12, 2011

On Tuesday, Manhattan federal judge Jed Rakoff agreed to decide whether Irving Picard’s $267 million clawback case against ABN Amro and related defendants belongs in federal court rather than in Manhattan bankruptcy court, where the Bernard Madoff bankruptcy trustee filed it as an adversary proceeding. That’s bad news for Picard and his team at Baker & Hostetler. So far, Judge Rakoff has decided that he has jurisdiction over at least part of every Madoff case he’s considered, and he’s proceeded to decimate Picard’s recovery theories in his HSBC and Mets rulings.

What’s intriguing about the ABN Amro withdrawal motion, though, is that the bank’s lawyers at Latham & Watkins, as well as Morrison & Foerster on behalf of co-defendant Rye Portfolio, are pointing to a June 23 U.S. Supreme Court opinion involving Anna Nicole Smith’s claim to part of her billionaire husband’s estate. Sadly, neither the former Playboy Playmate nor the stepson she sued to recover more than $400 million lived to see the high court’s ruling. But the Supreme Court’s opinion in Stern v. Marshall could turn out to be the most important legacy of the onetime tabloid darling Anna Nicole Smith, or, as she’s known to the Justices, Vickie Lynn Marshall.

The Supreme Court’s controversial 5-to-4 decision isn’t one of those rulings whose implications are immediately evident, like, say, Morrison v. National Australia Bank. Indeed, to call the facts underlying Stern v. Marshall idiosyncratic would be sort of like saying Anna Nicole was buxom. Here’s a highly abbreviated version of the story: Anna Nicole’s billionaire husband (of a little more than a year) left her nothing in his will. She filed for bankruptcy. Her stepson, Pierce Marshall, filed a claim in the bankruptcy, alleging that Anna Nicole defamed him when she said in state probate court that he fraudulently induced his father to disinherit her. Anna Nicole responded to her stepson’s bankruptcy court claim with a counterclaim for tortious interference. After a bench trial, the bankruptcy court agreed with Anna Nicole and entered a $400 million judgment against Marshall.

The Supreme Court, however, found that Anna Nicole’s bankruptcy judge did not have the right, under the U.S. Constitution, to enter final judgment on a claim that doesn’t fall under the Bankruptcy Code’s definition of core bankruptcy issues and isn’t part of the bankruptcy estate’s claims process. (Congress created federal bankruptcy courts; the Constitution created federal district courts.) Claims involving non-core bankruptcy issues outside of the bankruptcy claims process, under the Supreme Court’s ruling, have to receive final adjudication from a federal district court. Bankruptcy judges may only issue findings of fact and recommendations, as if they were federal magistrates.

For Anna Nicole’s estate, the consequences of the Court’s ruling were all too clear: Her heirs don’t get the money the bankruptcy court awarded. But for everyone else, figuring out what Stern v. Marshall means has not so easy. In part, that’s because of the Court’s insistence that its ruling is intended to be narrowly construed. “We do not think the removal of counterclaims such as Vickie’s from core bankruptcy jurisdiction meaningfully changes the division of labor in the current statute,” wrote Chief Justice John Roberts for the majority. The Court weighed in, the Chief Justice wrote, because “We cannot compromise the integrity of the system of separated powers and the role of the Judiciary in that system, even with respect to challenges that may seem innocuous at first blush.”

Notwithstanding the Court’s words, defendants have invoked Stern v. Marshall in asking to move even what seem like core bankruptcy cases to federal court. My eagle-eyed Reuters colleague Nick Brown reported late last month on JPMorgan’s reliance on Anna Nicole Smith’s case in its motion to move a Lehman bankruptcy suit to federal court. JPMorgan’s lawyers at Wachtell, Lipton, Rosen & Katz could credibly argue that the Lehman estate’s claims against the bank are not rooted in bankruptcy law, so under Stern v. Marshall they belong in federal court. ABN Amro and Rye Portfolio, however, took a much more expansive view of the Supreme Court’s holding, arguing that Stern v. Marshall means bankruptcy judges can’t decide even fraudulent conveyance claims — which are traditionally in the bankruptcy court’s purview — unless the clawback defendant has also asserted its own claim in the bankruptcy proceeding.

And the Madoff defendants aren’t the only ones positing that interpretation of Stern v. Marshall. “Litigants are using the decision to call into question bankruptcy judges’ authority to hear and determine a myriad of matters that they historically have handled without any previous legitimate question that they could do so,” Skadden, Arps, Slate, Meagher & Flom bankruptcy partners Mark McDermott and George Zimmerman wrote in an Oct. 11 client alert on Stern v. Marshall. “Stern has been a shock to the bankruptcy system. Debtors, creditors’ committees, and litigation trustees have pursued fraudulent transfer litigation in bankruptcy courts for years, with no question about the propriety of doing so. Bankruptcy judges and litigants now must reconsider this fundamental assumption in light of Stern.”

But Craig Goldblatt of Wilmer Cutler Pickering Hale and Dorr, one of the trio of lawyers who represented Marshall at the Supreme Court, argued in a Sept. 16 speech to the American Bankruptcy Institute that Stern v. Marshall didn’t change the law; it clarified previous Supreme Court rulings that limited the power of bankruptcy courts. Those rulings, Goldblatt asserted, simply weren’t taken into account by bankruptcy judges and lawyers. “It is worth reflecting for a minute on how wrong the bankruptcy bench and bar has been on this fundamental question of bankruptcy jurisdiction for more than 25 years,” he told the ABI. “A bankruptcy lawyer who argued before the Stern decision that a fraudulent conveyance case couldn’t be a core matter in a case in which the defendant had not filed a proof of claim would elicit nothing but laughter from the bench. If any of you doubts that, I’m happy to send you the transcript.”

Will Stern v. Marshall end up being important in the Madoff case? Perhaps not; Judge Rakoff wasn’t shy about asserting his jurisdiction over clawback claims even before anyone cited the Supreme Court’s ruling in his courtroom. In other big bankruptcies, though, we’re going to see federal judges encroaching on territory that traditionally belonged to bankruptcy courts, at least until appellate courts have a say about the Supreme Court’s intentions in Stern v. Marshall.

Anna Nicole Smith loved nothing more than public attention. She just probably never imagined that years after her death, it would be bankruptcy lawyers and judges who were still talking about her.

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