Bankruptcy courts occupy an odd place in the judicial system. In Stern v. Marshall,1 the Supreme Court held that the Constitution guarantees parties in bankruptcy proceedings an Article III judge for certain claims.2 Later, in Wellness International Network, Ltd. v. Sharif,3 the Court determined that non–Article III bankruptcy judges could nevertheless adjudicate these “Stern claims” with the “knowing and voluntary” consent of the parties.4 Recently, in Excluded Lenders v. Serta Simmons Bedding, L.L.C. (In re Serta Simmons Bedding, L.L.C.),5 the Fifth Circuit applied an expansive interpretation of the Wellness exception on its way to resolving an important contract law question. The court’s finding of consent to bankruptcy court adjudication6 despite the careful and consistent objections of the parties highlights the extent to which Wellness has weakened Stern’s Article III guarantee.
The COVID-19 pandemic in 2020 exacerbated Serta’s already serious financial troubles.7 To avoid bankruptcy, the company explored restructuring deals known as “liability management[] transactions.”8 Serta negotiated with competing groups of its preexisting lenders to borrow new money and reduce old debt.9 Ultimately, Serta picked one group of lenders (“the prevailing lenders”), who used their voting majority to amend the earlier loan agreements to facilitate a non–pro rata “uptier.”10 The defining characteristic of a non–pro rata uptier is that the debtor lets a slim majority of lenders jump to first in line for repayment in exchange for consent to amend earlier agreements.11
Serta’s uptier was aggressive. The prevailing lenders permitted Serta to create new, superpriority loans.12 They then exchanged $1.2 billion of old loans with Serta in return for $875 million of superpriority loans and lent Serta an additional $200 million with superpriority.13 As a result, Serta reduced its total debt and acquired the cash it needed to weather the pandemic.14 The prevailing lenders emerged first in line for repayment.15 Other secured creditors became effectively unsecured, unlikely to be repaid in the event of bankruptcy.16
Lenders excluded from the transaction immediately filed suit to block it. One set of plaintiffs, whom the Fifth Circuit referred to as the “Excluded Lenders,”17 had unsuccessfully competed with the prevailing lenders to obtain superpriority.18 These plaintiffs sued in New York state court in June 2020 but lost their preliminary injunction motion.19 Shortly thereafter, they voluntarily dismissed their suit.20 Another group of lenders — all funds affiliated with LCM Asset Management (LCM) — sued Serta in the Southern District of New York.21 Unlike the other excluded lenders, LCM had no knowledge of the liability management transaction negotiations until Serta publicly announced the uptier that June.22 LCM’s suit survived a motion to dismiss on claims for breach of contract and breach of the implied covenant of good faith and fair dealing.23 In November 2022, the other excluded lenders refiled in New York state court after a favorable decision in another uptier case.24
The controversy revolved around an exception in the loan agreement that allowed Serta to repurchase loans from select lenders through undefined “open market purchases.”25 Under the contract, Serta could normally repurchase loans only from all lenders in proportion to how much they had lent.26 This right to “ratable treatment” required consent from all affected lenders to amend.27 Although Serta amended other provisions of the contract to effectuate the uptier, it could not amend the right to ratable treatment.28 When Serta and the prevailing lenders swapped old loans for new superpriority loans, they risked breaching the agreement’s ratable-treatment provision unless the “open market purchase” exception applied.29 The excluded lenders contended that a privately negotiated debt-for-debt swap limited to just the prevailing lenders could not be an “open market purchase.”30
The lawsuits ground to a halt after Serta filed for bankruptcy in January 2023.31 Serta filed before Chief Judge Jones in the Southern District of Texas, automatically staying all suits against Serta just before discovery was to close in the LCM suit.32 Although the non-LCM excluded lenders tried to continue their New York suit against the prevailing lenders, Serta obtained an order from Chief Judge Jones staying those claims too.33 In the bankruptcy court, Serta and the prevailing lenders promptly launched an adversary proceeding against the excluded lenders.34 They sought declaratory judgment on the very same claims brought in New York: whether the uptier violated Serta’s loan agreement and whether Serta and the prevailing lenders breached the implied covenant of good faith and fair dealing.35
Chief Judge Jones granted partial summary judgment for Serta and the prevailing lenders.36 He ruled that the uptier did not violate the ratable-treatment provision as the meaning of “open market purchase” was “clear and unambiguous.”37 In order to immediately appeal the decision, the excluded lenders requested entry of partial final judgment.38 Chief Judge Jones granted the request and certified the open market purchase question for immediate appeal to the Fifth Circuit.39 He denied summary judgment on the implied covenant claim, which proceeded to bench trial.40 After trial, he again ruled for Serta and the prevailing lenders, finding they had acted in good faith.41 It was the non-LCM excluded lenders whose conduct “raise[d] an eyebrow” because they sued over the same hardball tactics they had attempted themselves.42 Finally, Chief Judge Jones confirmed Serta’s plan of reorganization, which provided a controversial indemnity to the prevailing lenders for any future liability arising from the uptier.43
Notably, both excluded lender parties sought an Article III judge in their pleadings.44 They argued that the bankruptcy court lacked constitutional authority to resolve the implied covenant question.45 After trial, Chief Judge Jones ruled that the non-LCM excluded lenders had implicitly consented to the bankruptcy court’s authority by requesting summary judgment and failing to object at summary judgment and at trial.46 The court made no specific findings with respect to LCM’s consent but issued judgment anyway.47
The Fifth Circuit reversed.48 Writing for the panel,49 Judge Oldham first found the statutory requirements for jurisdiction satisfied.50 As to constitutional requirements, the parties’ implied consent cured any Stern problem.51 The panel held that “the bankruptcy court did not err when it found that the Excluded Lenders implicitly consented to non-Article III adjudication.”52 Although the bankruptcy court made no specific findings about LCM’s consent, the panel held that LCM had implicitly consented based on its request for partial final judgment on the open market purchase claim, “the connection between that claim and [LCM’s] counterclaims,” and considerations of “efficiency and gamesmanship.”53 The court stressed gamesmanship in particular.54 Having agreed to partial final judgment on the open market purchase question, the parties could not object to the bankruptcy court adjudicating closely related claims.55
On the merits, the Fifth Circuit parted from the bankruptcy court. It concluded that the uptier was not an “open market purchase.”56 Relying on dictionaries and New York case law, the court reasoned that an “open market purchase” must take place on a relevant market, such as the secondary market for syndicated loans.57 Furthermore, Serta’s expansive reading of “open market purchase” would “render [as] surplusage” the agreement’s other ratable-treatment exception.58 Lastly, the panel held that the plan indemnity violated the Bankruptcy Code.59 It rejected the appellees’ contention that confirmation of the plan had made the indemnity challenge equitably moot.60 The court excised the indemnity from the plan and remanded the case for reconsideration of the excluded lenders’ counterclaims.61
Though the Serta decision was highly anticipated for its contract-interpretation holding,62 its less-discussed jurisdictional holding merits attention too. The Fifth Circuit appeared to craft an even more permissive holding on implied consent than the scant case law from the courts of appeals would suggest. The panel’s affirmation of the bankruptcy court’s authority demonstrates the difficulty of obtaining an Article III judge in bankruptcy after Wellness.
Stern matters to creditors contesting liability management transactions because bankruptcy rules flip the standard choice-of-forum playbook on its head. As “the master of the complaint,” a plaintiff-creditor normally chooses where to bring its state law contract claim.63 But the debtor ordinarily chooses where to file for bankruptcy.64 And when a debtor files, nearly all pending and future litigation against it is automatically stayed.65 The Bankruptcy Code enables debtors to file virtually anywhere.66 Manufacturing venue is as easy as incorporating a new subsidiary in the desired district and having it file for bankruptcy there.67 Increasingly, sophisticated debtors have been able to secure not just their desired district but also their desired judge by manipulating division assignment.68 Consequently, excluded lenders seeking damages after a liability management transaction often must bring their claims before a bankruptcy judge of the debtor’s choosing.69
Predictably, debtors choose the most favorable venues. In recent years, the Southern District of Texas has emerged as the country’s leading corporate bankruptcy venue70 — largely due to the efforts of former Chief Bankruptcy Judge David Jones.71 Some of the reasons for Chief Judge Jones’s popularity were laudable. Lawyers appreciated Chief Judge Jones’s efficiency and responsiveness, as well as his facility with complex bankruptcy issues.72 More perniciously, debtors flocked to Houston because Chief Judge Jones built a reputation for prioritizing speedy reorganizations and debtors’ interests over creditors’ entitlements.73 It is no mystery, then, why Serta and its lawyers decided to file in his court.
Article III of the Constitution provides one limited option for lenders to escape less-than-ideal bankruptcy courtrooms. In Stern v. Marshall, the Supreme Court held that non–Article III courts, such as bankruptcy courts, cannot adjudicate claims involving only private rights.74 Although the Court “has not been entirely consistent” in defining the scope of this doctrine,75 “traditional contract action[s] arising under state law”76 between two private parties are assuredly matters of private rights.77 Breach of contract and breach of implied covenant of good faith and fair dealing claims fall under this definition.78 For a bankruptcy court to resolve these types of claims, the claim must “stem[] from the bankruptcy itself or . . . necessarily be resolved in the [bankruptcy] claims allowance process.”79ed. 2025). In Wellness International Network, Ltd. v. Sharif, the Court added that “Article III permits bankruptcy courts to decide Stern claims submitted to them by consent.”80 If consent is necessary but lacking, the bankruptcy court can issue a report and recommendation for the district court to review entirely de novo.81 By denying consent, excluded lenders get the benefit of factfinding from a judge not chosen by the debtor.
Denying consent is easier said than done. The Court in Wellness held that parties can implicitly consent to bankruptcy court jurisdiction, so long as that consent is “knowing and voluntary.”82 The party must be “aware of the need for consent and the right to refuse it, and still voluntarily appear[] to try the case.”83 At the same time, the Wellness Court stressed the “pragmatic virtues” of “increasing judicial efficiency and checking gamesmanship” that underpin the rule.84 The courts of appeals are still fleshing out when parties implicitly consent under Wellness.85 At a minimum, failure to timely object establishes implied consent.86 Filing a motion seeking judgment can also constitute consent.87 Even when litigants object, too much participation in the litigation can create consent.88 One bankruptcy court — quoted at length by Chief Judge Jones in his Serta opinion89 — has suggested that the only way to deny consent is to “promptly move[] for withdrawal of the reference and prosecute[] that motion to conclusion in the District Court.”90
Like Chief Judge Jones, the Serta court elided many of the nuances in the parties’ litigation choices. In finding consent as to all claims, the panel stressed that the parties requested partial final judgment on the open market purchase question.91 But it’s not clear why the request mattered under Wellness because this claim arguably never required consent for adjudication in the first place under Stern. For all excluded lenders, priority in Serta’s bankruptcy depended on whether Serta breached the loan agreement by swapping loans with the prevailing lenders.92 Therefore, “the process of adjudicating [the] proof[s] of claim would necessarily resolve” the open market purchase question, excepting it from the guarantee of an Article III judge.93 In fact, the non-LCM excluded lenders took pains to distinguish their claims against the prevailing lenders from their claims against Serta for this reason.94
Moreover, the Fifth Circuit adopted debatable factual contentions from Chief Judge Jones’s opinion. For example, the panel stated that the non-LCM excluded lenders “failed to object at the summary judgment stage, before trial, and at trial.”95 While these lenders did fail to mention Stern or Wellness at summary judgment and at trial,96 their pre-trial brief plainly argued that the bankruptcy court lacked consti-tutional authority to ajdudicate their claims against the prevailing lenders.97 The panel also seemed to say the non-LCM excluded lenders requested summary judgment on the implied covenant claim too.98 But their brief asked the court to allow discovery to continue on the implied covenant claim.99 Appellate courts review the bankruptcy judge’s finding of Wellness consent for clear error,100 and these mistakes may not have been material. Still, Serta demonstrates how the clear error standard makes it more difficult to obtain an Article III judge. Indeed, clear error deference is ironic because parties in bankruptcy seeking an Article III judge do so to get nondeferential review.
The Fifth Circuit stretched Wellness especially far to find implied consent from LCM. The LCM lenders duly objected in their initial answer101 and reiterated their objections before,102 during,103 and after trial.104 Only at summary judgment did LCM neglect to mention Stern,105 but the open market purchase question resolved at summary judgment arguably did not require consent to begin with. Recognizing that the bankruptcy court had made no consent findings about LCM, the panel hung its hat on the request for partial final judgment.106 The Fifth Circuit’s affirmation of consent despite LCM’s careful and consistent denials suggests that a prompt motion for withdrawal of the reference may be the only surefire way to avoid inadvertent consent.107
To be sure, the Fifth Circuit did not have to break new ground to uphold the finding of consent. For example, the appellants appealed straight to the circuit court, bypassing the district court.108 On appeal, nobody addressed Stern or Wellness;109 the court actually raised it sua sponte. One circuit court has treated both of these choices as evidence of Wellness consent, albeit in a nonprecedential opinion.110 But the Fifth Circuit chose to focus on only the parties’ actions before the bankruptcy judge, and it did so in a precedential opinion.111 Creditors in the popular bankruptcy destination of Houston will now find it even tougher to obtain an Article III judge, and perhaps creditors in other circuits will too.
Although the difference between bankruptcy judges and Article III judges may seem small, it matters for excluded lenders. After a liability management transaction, excluded lenders can sue nondebtors on a variety of factbound Stern claims, in particular breach of the implied covenant of good faith and fair dealing.112 If the bankruptcy court issues judgment, adverse factual findings — such as whether prevailing lenders acted in good faith113 — get clear error deference on appeal.114 In this case, LCM had good reason to avoid factfinding from a debtor-friendly judge because its clean hands made it a stronger implied covenant claimant.
At the same time, there are risks to making Stern objections. Withdrawing claims might antagonize the bankruptcy judge, who will certainly decide other matters in the case.115 The bankruptcy judge could also surprise by ruling in an excluded creditor’s favor.116 Additionally, the district judge might not conduct truly independent review.117 Even so, excluded lenders seem to believe objecting is worth it. In at least two subsequent proceedings challenging uptiers, excluded lenders have litigated the issue.118
Moving beyond tactics, today’s litigation over liability management transactions demonstrates the pitfalls of Wellness. As the Chief Justice noted in dissent, “[t]he Framers adopted the formal protections of Article III for good reasons.”119 Some bankruptcy judges feel pressure to favor debtors and their allies.120 This tendency is exacerbated by the Bankruptcy Code’s generous venue and jurisdictional rules, which encourage forum shopping by debtors. If courts continue to apply Wellness in capacious ways, these pressures will erode Article III’s promise of “impartial and independent federal adjudication.”121