08/05/2011 – Defendant’s Supplemental Memorandum of Law in Support of Motion to Dismiss filed in the Lehman Commercial Paper Inc. Adversary Proceedings by JPMorgan Chase Bank, N.A. before U.S. Bankruptcy Judge James M. Peck in the Southern District of New York (Manhattan) filed by  Wachtell, Lipton, Rosen & Katz (New York, NY) by attorney Paul Vizcarrondo, Jr.; Of counsel: Harold S. Novikoff, Amy R. Wolf, Douglas K. Mayer, David C. Bryan, Emil A. Kleinhaus and Alexander B. Lees .

JPMorgan Chase Bank, N.A. (“JPMorgan” or “Defendant”) argues that, in view of Stern v. Marshall, 131 S. Ct. 2594 (2011) (“Stern”), the Bankruptcy Court lacks authority to determine any of the 49 claims in the Amended Complaint of Lehman Brothers Holdings Inc. (“LBHI”) and Official Committee of Unsecured Creditors of Lehman Brothers Holdings Inc. (collectively with LBHI, “Plaintiff”). Registered users click here to see a copy of this brief.

Defendant’s reading of Stern is that it provides for a two part test that “does not permit a bankruptcy court to determine a cause of action that seeks to augment the estate and that will not necessarily be decided as part of the claims-allowance process.” Defendant then cites the Bankruptcy Court approved, post petition agreed deferral of any application of Section 502(d) to Defendant’s claims. Defendant postulates that Stern and the Section 502(d) deferral agreement require that all of Plaintiff’s claims be decided by an Article III court.

Defendant’s Preliminary Statement

Defendant summaries its arguments as follows:

First and foremost, an Article III court must determine plaintiffs’ damages claims brought under New York law. Those claims, through which plaintiffs seek to augment the estate by recovering damages for JPMorgan’s alleged misconduct in precipitating LBHI’s bankruptcy filing, are legally indistinguishable from the state-law tortious-interference counterclaim in Stern. Like the counterclaim in Stern, granting relief on the damages claims in the Amended Complaint would “involve[] the most prototypical exercise of judicial power: the entry of a final, binding judgment by a court with broad substantive jurisdiction, on a common law cause of action.” 131 S. Ct. at 2615 (emphasis omitted). Accordingly, Stern dictates that an Article III tribunal must determine all of plaintiffs’ damages claims, even if there is some factual overlap between those claims and any objection that may be filed to JPMorgan’s proof of claim.

An Article III court must also determine plaintiffs’ claims under the Bankruptcy Code to avoid or recover pre-petition transfers and alleged setoffs. Plaintiffs may argue that, under section 502(d) of the Bankruptcy Code, these avoidance claims should be resolved in the context of an objection to JPMorgan’s proof of claim. At least in the unique circumstances of this case, however, section 502(d) is not applicable. In the court-approved post-petition Collateral Disposition Agreement (the “CDA”) between JPMorgan and LBHI, JPMorgan transferred to LBHI numerous securities that it held as collateral, JPMorgan’s claims were provisionally allowed, and JPMorgan was provisionally authorized to apply to its claims the cash collateral that it held. As part of that post-petition contract, the Debtors, supported by the Creditors’ Committee, agreed that section 502(d) will have no force or effect until after this adversary proceeding and all other disputes between the parties have been fully and finally resolved. Section 502(d), therefore, does not apply in this adversary proceeding, and plaintiffs’ avoidance claims are no different from their other claims to augment the estate that fall outside the claims-allowance process and must be determined by an Article III court.

Similarly, an Article III court must determine plaintiffs’ remaining claims, including those seeking declaratory relief, avoidance of obligations, and equitable subordination. Plaintiffs’ claims for declaratory relief, as well as their claims to avoid LBHI’s obligations, function as predicates to plaintiffs’ affirmative claims seeking to augment the estate. And the claim for equitable subordination is simply a repackaged version of plaintiffs’ common-law damages claims, and thus requires the same exercise of Article III judicial power.

Consequently, the only mechanism for determination of the claims in the Amended Complaint that is consistent with Article III of the Constitution, as well as the Judicial Code, the Bankruptcy Rules, and the agreement of the parties, is their resolution by the District Court.

Does Stern Limit the Effect of a Creditor’s Proof of Claim

One important interpretation of the effect of Stern is not indicated in Defendant’s preliminary statement. Defendant asserts that Stern “exploded” a basic premise of practitioners in advising clients on whether to file and the effect of filing of a proof of claim.

In light of the contrast between Northern Pipeline and Granfinanciera on the one hand, and Katchen and Langenkamp on the other, it has been routine for bankruptcy practitioners and commentators to consider a creditor’s filing of a proof of claim to be a dispositive event establishing the adjudicatory authority of a bankruptcy court over any claims brought by the estate against the creditor, or at the very least any such claims that are factually intertwined with the subject of the creditor’s proof of claim. Stern decisively exploded that premise, rejecting the contention that Pierce’s filing of a proof of claim in Vickie’s bankruptcy case rendered constitutional the bankruptcy court’s determination of Vickie’s common-law tort counterclaim.

The Court reasoned that Vickie’s counterclaim was distinguishable from the preference claims in Katchen and Langenkamp, and akin to the claims in Northern Pipeline and Granfinanciera, because it not only “attempt[ed] to augment the bankruptcy estate,” but also was “not necessarily resolvable by a ruling on the creditor’s proof of claim in bankruptcy.” 131 S. Ct. at 2611, 2616. The Court explained that, in contrast to Katchen and Langenkamp, “Pierce’s claim for defamation in no way affect[ed] the nature of Vickie’s counterclaim for tortious interference as one at common law that simply attempts to augment the bankruptcy estate — the very type of claim that we held in Northern Pipeline and Granfinanciera must be decided by an Article III court.” Id. at 2616.

The Court recognized that Vickie’s tortious-interference counterclaim bore a sufficient legal and factual connection to Pierce’s defamation claim that it might amount to a compulsory counterclaim. Id. at 2617. Specifically, the overlap “was the question whether Pierce had in fact tortiously taken control of his father’s estate in the manner alleged by Vickie in her counterclaim and described in the allegedly defamatory statements.” Id. Nonetheless, the Court found that the precise degree of connection did not matter, because “there was never any reason to believe that the process of adjudicating Pierce’s proof of claim would necessarily resolve Vickie’s counterclaim.” Id. (emphasis added). And that was true even though Vickie’s counterclaim and Pierce’s claim both raised the question of Pierce’s alleged tortious control of his father’s estate. Id.

The Court so concluded because a decision in Vickie’s favor on her counterclaim necessitated rulings on legal and factual issues “above and beyond” the question of tortious control posed in common by both Vickie’s counterclaim and Pierce’s proof of claim. Id. Specifically, in order to decide Vickie’s counterclaim, the presiding court would need to determine “whether Texas recognized tortious interference with an expected gift as a valid cause of action, what the elements of that action were, and whether those elements were met.” Id. The court would further need to determine whether Vickie had established (1) the existence of an expectancy of a gift; (2) a reasonable certainty that the expectancy would have been realized but for the interference; (3) an entitlement to compensatory damages; and (4) an entitlement to punitive damages. Id. Moreover, the Court held, Vickie’s counterclaim sought “to augment the bankruptcy estate,” and thus could not be resolved by a bankruptcy court, even if the claim had “some bearing on a bankruptcy case.” Id. at 2618 (quoting Granfinanciera, 492 U.S. at 56; emphasis in original).³

The baseline lesson from Stern, then, is its holding that a bankruptcy court is not constitutionally permitted to determine claims by a bankruptcy estate against a creditor that are “not necessarily resolvable” in the context of ruling on the creditor’s proof of claim (in contrast to the preference claims in Katchen and Langenkamp), and that seek to augment the bankruptcy estate (like the claims in Northern Pipeline and Granfinanciera).