Wellness International Network, Limited, et al. v. Sharif

Case No 12-1349 (7th Cir. August 12, 2013)
The Seventh Circuit Court of Appeals reversed and remanded the District Court’s ruling, which had affirmed the Bankruptcy Court’s entry of default judgment on a state law alter-ego claim, in which the Seventh Circuit held that an objection to a bankruptcy judge’s authority to enter final judgment on state court based claims raises a constitutional authority issue that is not waivable under Stern v. Marshall, 131 S. Ct. 2594 (2011). See also 28 U.S.C. 157. Incidentally, the Seventh Circuit affirmed the District Court’s ruling, which affirmed the Bankruptcy Court’s entry of default judgment denying discharge of Sharif’s debts. The Seventh Circuit also reversed and remanded the Bankruptcy Court’s fee awards, with instructions to the District Court for recalculation of the award.
Procedural context:
This was an appeal brought by Sharif challenging the District Court affirmance of the Bankruptcy Court’s entry of default judgment in favor of Wellness International Network (“WIN”) on a judgment entered by the Bankruptcy Court respecting a state law claim, sounding in alter ego claims brought in order to reach assets held in a trust. The appeal also sought to reverse judgment respecting the four counts dealing with the 727 discharge causes of action.
Richard Sharif is a debtor that apparently had a long history of failing to comply with discover requests, which resulted in the Court of the Northern District of Texas entering a judgment of $650,000 against him, causing him to file for Chapter 7 bankruptcy in the Northern District of Illinois. Wellness International Network (“WIN”) initiated an adversary proceeding, filing a five-count complaint alleging, among other things, the claim that Sharif placed assets in a trust that is his alter ego and those assets should be treated as part of the bankruptcy estate. Throughout the adversary proceeding, Sharif continually left discovery requests unfulfilled or incomplete, causing WIN to file a motion to compel discovery, which Sharif failed to fully comply with. The Bankruptcy Court issued default judgment in favor of WIN on all five counts, including the alter-ego claim, and ordered Sharif to pay WIN’s attorneys’ fees. The District Court affirmed. Sharif appealed the District Court decision, arguing that, among other things, that: (1) the bankruptcy court lacked jurisdiction to enter a final judgment on the alter-ego claim because of its roots in state law, and (2) the bankruptcy court abused its discretion in awarding default judgment as a discovery sanction. In support of his jurisdictional argument, Sharif relied on Stern v. Marshall, 131 S. Ct. 2594 (2011) which stands for the proposition that a bankruptcy court lacks jurisdiction under Article III, § 1, to enter a final judgment on a bankruptcy petitioner’s state-law claims. WIN responded that Sharif had waived his Stern-argument by failing to include it in his first appellate brief, and therefore consented to a final adjudication by a bankruptcy judge. The dispute centered on whether or not the ordinary principals of waiver apply to a Stern objection, under which a defendant who waits too long to assert an argument loses the opportunity to raise it. The Seventh Circuit drew a distinction between challenges to a bankruptcy court’s statutory authority, which are waivable under Stern, and those challenges to a bankruptcy court’s constitutional authority. The Seventh Circuit held that an objection to the bankruptcy court’s constitutional authority is not waivable under Stern, and found that because Sharif challenged the bankruptcy court’s constitutional power to enter judgment on the alter-ego claim, his failure to assert this argument in a timely fashion did not waive his right to raise it at a later point. The Seventh Circuit then turned to the merits of his claim, finding that WIN’s alter-ego claim was a state-law claim between private parties and is wholly independent from federal bankruptcy law. The Seventh Circuit remanded the issue to the District Court to determine if the alter-ego claim is a “core” issue, with instructions that if the District Court finds it to be a core issue, case law mandates that the reference of the claim to the bankruptcy court be withdrawn to the District Court for fresh discovery hearings. Incidentally, the Seventh Circuit also determined that the awarding default judgment on the four non-dischargeability counts and an award of attorneys’ fees as a discovery sanction was not an abuse of discretion, citing Sharif’s continual failure to comply with discovery orders and his lack of good faith as reasons justifying the strong medicine of default judgment and sanctions.
Flaum, Sykes and Tinder.

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