Kiviti v. Bhatt: Fourth Circuit Brain Twister

September 20, 2023
By: William L. Hallam

The scope of Bankruptcy Court jurisdiction has been the subject of numerous decisions, including multiple decisions by the United States Supreme Court since Bankruptcy Courts were created by the Bankruptcy Reform Act of 1978. Initially, Congress created Bankruptcy Courts as stand-alone courts and purported to give them exclusive jurisdiction over bankruptcy cases and proceedings that arose in, or related to, bankruptcy cases. However, in 1982, in Northern Pipeline Company v. Marathon Pipe Line Company, the Supreme Court held that Congress had exceeded its Constitutional authority by granting courts not formed under Article III of the Constitution the power to adjudicate matters reserved for Article III courts to decide.

Congress reacted to the Northern Pipeline decision by vesting jurisdiction over bankruptcy cases and proceedings that arose in, or related to, bankruptcy cases in Article III U.S. District Courts in the first instance, but authorizing those courts to delegate their jurisdiction to Article I Bankruptcy Courts. To preserve the jurisdiction of Article III District Courts to decide issues that related to bankruptcy cases but that fell within the traditional jurisdiction of Article III courts, Congress empowered Bankruptcy Courts to enter final orders only in the main bankruptcy case and proceedings in the main bankruptcy case defined as “core proceedings” and provided that Bankruptcy Courts could only make recommendations subject to de novo review by Article III district courts, in “non-core” proceedings.

In 2011, in Stern v. Marshall, the Supreme Court held that even if Congress had designated a proceeding that related to a bankruptcy case by statute as a “core proceeding” in which a Bankruptcy Court could enter a final order by statute, the Constitution nevertheless prohibited the Bankruptcy Court from entering a final order if the matter required resolution of an issue traditionally decided by Article III courts.

Against this backdrop, the Fourth Circuit decided Kiviti v. Bhatt on September 14, 2023. The essence of the decision, that parties cannot artificially make an order final so that it can be appealed, is not surprising. How that Fourth Circuit got there is.

The Kivitis had hired Bhatt, who represented to them that he was a licensed contractor, to renovate their home and paid him $58,770. Bhatt’s work was defective and it turned out that Bhatt had lied about being licensed. When the Kivitis sued him to get their money back, Bhatt filed for bankruptcy.

The Kivitis filed a two count adversary proceeding against Bhatt. In count 1, they sought a money judgment for $58,770. In count 2, they sought a determination that Bhatt’s debt to them could not be discharged because it had been incurred by “false pretenses, a false representation, or actual fraud.”  The Bankruptcy Court dismissed count 2 with prejudice. However, count 1 remained pending.

Neither the Kivitis nor Bhatt wanted to incur legal fees litigating whether the Kivitis were entitled to a money judgment if the debt was dischargeable and the Kivitis were going to be paid only cents on the dollar, if anything. Consequently, the Kivitis and Bhatt agreed to the dismissal of count 1 without prejudice so that the Bankruptcy Court’s dismissal of count 2 would be final and the Kivitis could appeal to the U.S. District Court. On appeal, the District Court affirmed the Bankruptcy Court’s dismissal of count 2 of the Kivitis’ complaint. They then appealed to the Fourth Circuit.

The Fourth Circuit began its opinion by saying that it “must police Congress’s limits on judicial review, even when both parties would rather we not.”  Concluding that the Bankruptcy Court’s dismissal of count 2 was not a final order because count 1 remained pending at that time, the Fourth Circuit held that the District Court did not have jurisdiction to consider the Kivitis’ appeal and vacated the District Court’s order affirming the decision of the Bankruptcy Court.

The Kivitis argued that even though count 1 was not dismissed when court 2 was dismissed, the dismissal of count 2 effectively made count 1 moot since a judgment in their favor on count 1 would do them no good if Bhatt could discharge his debt to them. The Fourth Circuit rejected that argument, making several remarkable statements in the process.

The Fourth Circuit started with the proposition that “Mootness is an Article III doctrine, and bankruptcy courts are not Article III courts.”  It followed, according to the Fourth Circuit, that “since bankruptcy courts are not Article III courts, they do not wield the United States’s judicial Power…[s]o they can constitutionally adjudicate cases that would be moot if heard in an Article III court.”

But, the Kivitis argued, if the Bankruptcy Court derives its jurisdiction from a delegation of jurisdiction by the District Court and count 1 would be moot if pending before that Article III court, how could it not be moot in the Bankruptcy Court as well?  The answer, according to the Fourth Circuit, is that the constraint on the District Court’s Article III authority “does not constrain the bankruptcy court.”  “Once a case is validly referred to the bankruptcy court, the Constitution does not require it to be an Article III case or controversy for the bankruptcy court to act.”  The Fourth Circuit went on to say:

Bankruptcy courts, as statutory creatures, have whatever power Congress lawfully gives them. So to see if bankruptcy courts can decide matters outside the judicial Power, we check to see if Congress has given them that power. And Congress has said that bankruptcy courts “may hear and determine all [bankruptcy] cases…and all core proceedings…referred to them by a district court…[n]ot just those that could be fully adjudicated in district court. Once a bankruptcy case lands in bankruptcy court…whether the proceeding could itself be adjudicated in an Article III court is of no moment.

Reconciling Stern v. Marshall and Kiviti v. Bhatt is challenging at best. In Stern v. Marshall, the Supreme Court said that a Bankruptcy Court cannot Constitutionally exercise jurisdiction over disputes traditionally within the jurisdiction of Article III courts even if District Court delegated its Article III jurisdiction to the Bankruptcy Court and the dispute fell within the statutory definition of a “core proceeding” in which Congress authorized Bankruptcy Courts to enter final orders. According to Kiviti v. Bhatt, however, a Bankruptcy Court, which derives its jurisdiction from a delegation by the Article III District Court, can decide matters that the District Court itself could not decide because Congress gave the Bankruptcy Court that power in the very same statute that Stern said could not Constitutionally confer on Bankruptcy Courts the power to decide matters that the District Court would traditionally decide. In other words, to use the Fourth Circuit’s terminology, Congress could not “lawfully” give Bankruptcy Courts the power to decide matters traditionally reserved for Article III courts, but could, in the same statute, lawfully give the Bankruptcy Courts the power to decide issues that Article III courts cannot decide.