This post is designed to inform homeowners about withrawing reference in Bankruptcy proceedings. Simply put, when a homeowner is already pursing its foreclosure case in the Federal Court, and later files an emergency chapter 13 bankruptcy to protect his/her home from foreclosure. The homeowner in certain cases may opt to pursue the lender via bankruptcy adversary proceeding which is a seperate proceeding from the Chapter 13 automatic stay protection. What usually happens is that the homeowner may opt to use same causes of action as used in the Federal case, to pursue the Bankruptcy adversary proceeding. When this happens, the lender’s attorneys usually files what is known as “Motion for Withdrawal of reference” citing that the causes of actions in Chapter 13 adversary proceedings were the same as the ones in the Federal case, therefore that it would be better to withdraw the references in the Bankruptcy proceeding and remind them back to the Federal proceeding as that would serve best for judicial economy and to avoid multiple payment of damages from two different jusisdictions of the same material facts of causes of action. The Bankruptcy judges with their descretions can then decide, if the causes of action listed in the Bankruptcy proceeding would require the withdrawal of the either “Some of the causes of action or the Entire Adversary proceeding” as filed, since those causes of actions were already included in the Federal proceeding. Or whether some causes of actions in the Adversary proceeding were different and thus require that they remain in the Adversary proceeding for the case to continue in the Bankruptcy forum.

The number of reported cases dealing with motions for withdrawal of the reference appears to be on the rise. Practitioners need to be cognizant of this option and make an early determination as to whether to pursue withdrawal of the reference from the bankruptcy court under 28 U.S.C. §157(d). A well-considered motion to withdraw the reference is an important strategy that may result in a more favorable outcome for targets of bankruptcy litigation.

The district court may withdraw, in whole or in part, any case or proceeding referred under this section, on its own motion or on timely motion of any party, for cause shown. The district court shall, on timely motion of a party, so withdraw a proceeding if the court determines that resolution of the proceeding requires consideration of both title 11 and other laws of the United States regulating organizations or activities affecting interstate commerce. In an early case interpreting this statute, the district court in the Southern District of New York examined the historical underpinnings of §157(d) (including a review of Northern Pipeline) and stated that the statute “reflects Congress’s perception that specialized courts should be limited in their control over matters outside their areas of expertise.” American Tel. & Tel. Co. v. Chateaugay Corp., 88 B.R. 582, 583 (S.D.N.Y. 1988).

Section 157(d) has two branches. It vests discretionary (also described as permissive) authority with the district court to withdraw the reference upon a showing of “cause” by the filing of a timely motion. It also mandates the withdrawal of the reference as to proceedings that involve non-title 11 federal laws that regulate or affect interstate commerce or organizations.

A motion to withdraw the reference is filed with the bankruptcy clerk but is decided by the district court in the district where the bankruptcy case arose pursuant to Rule 5011(a). If the district court withdraws the reference, the bankruptcy court is stripped of jurisdiction over the matters for which the reference is withdrawn. Patterson v. Williamson, 153 B.R. 32, 33 (E.D. Va. 1993). Section 157(d) also entitles the district court to withdraw the reference sua sponte, but does not relieve it from the requirement that cause be present for sua sponte permissive withdrawal.

The first step in this inquiry is to determine whether there are nonbankruptcy federal laws at issue in the proceedings. Then it is necessary to determine whether to proceed under discretionary or mandatory withdrawal standards, or both.

Timeliness Is Key
Early recognition of the option of seeking withdrawal of the reference is extremely important because the motion must be “timely” under either a discretionary or mandatory standard. A motion is timely, if brought as promptly as possible, in light of the developments in the bankruptcy proceeding or at the first opportunity. Hupp v. Educational Credit Management Corp., No. 07CV1232 WQH (NLS), 2007 WL 2703151, at *3 (D. Cal. Sept. 13, 2007). A motion to withdraw the reference may be untimely when a significant amount of time has passed since the moving party had notice of the grounds for withdrawing the reference or where withdrawal would have an adverse effect on judicial economy. Id.

In an often-cited case, a district court ruled that a motion to withdraw the reference was untimely when it was filed five months after the bankruptcy petition and only one month after the filed adversary complaint. In re Mahlmann, 149 BR 866, 870 (N.D. Ill. 1993). The court noted that the “the key issue is when the moving party was first aware nonbankruptcy federal laws must be dealt with in resolving the case.” Id. at 869. Of particular significance was the fact that the federal claims existed for some time before the bankruptcy, as evidenced by the movant’s civil action against the debtor related to those claims, which was filed more than eight months before the bankruptcy. Id. at 870. One court has even held that a motion to withdraw the reference should have been filed contemporaneously with the defendant’s answer to an adversary complaint because the presence of “other laws” requiring the withdrawal of the reference was known at that time. See Securities Group 1980, 89 B.R. 192, 194 (M.D. Fla. 1988) (emphasis added). The failure to file constituted a waiver of the right to do so. Id.

The timing of the motion may also be affected by whether a jury demand is being made. A motion to withdraw the reference should generally be filed at the time of an answer containing a jury demand to avoid the outcome in In re HA-LO Industries, where the motion was deemed untimely when the proponent, who filed a jury demand on July 24, 2003, did not move to withdraw the reference until Oct. 28, 2004. 326 B.R. 116 (Bankr. D. Ill. 2005).

While some courts have focused on whether prejudice exists (see In re The Singer Co. N.V., No. 01CV0165 (WHP)), a movant cannot rely on that soft of a standard. A motion to withdraw the reference should be filed as soon as possible after the issues are known and before the bankruptcy court has dealt with those issues.

Permissive Withdrawal
Assuming the motion is timely filed, what factors will persuade a district court to exercise its discretionary authority to grant permissive withdrawal? The definition of “cause” has been left to the courts to decipher; the legislative history is of little help.

An early articulation of the standard for determining cause directed the district court to consider the goals of uniformity in the administration of bankruptcy cases, reduce forum-shopping, foster the economical use of the parties’ resources and expedite the bankruptcy process.

Holland Am. Ins. Co. v. Succession of Roy, 777 F.2d 992, 999 (5th Cir. 1985). The Holland case also cautioned that the district court “must keep one eye cocked toward the decision of the Supreme Court in [Northern Pipeline]… Whatever the precise teaching of [Northern Pipeline,] it holds, at a minimum, that Article I bankruptcy courts may not have original jurisdiction over adversary proceedings that do not intimately involve the debtor-creditor relationship and rest solely in issues of state law.”

More recent cases have added to the Holland factors with a focus on whether the proceeding is core or noncore and whether there is a right to a jury trial, while keeping an eye on judicial economy. In re County Seat Stores Inc., No. 01 CIV. 2966 (JGK), 2002 WL 141875, at *4 (S.D.N.Y. Jan. 31, 2002.) The presence of noncore issues are often central to the district court’s consideration of a motion to withdraw the reference and relates closely to judicial economy. In re Enron Corp., 317 B.R. 232, 234 (S.D.N.Y. 2004). Whether an adversary proceeding sought to be withdrawn is core or noncore has been held to be “the most important factor.” In re Coe-Truman Technologies Inc., 214 B.R. 183, 187 (N.D. Ill. 1997). While §157(b)(1) permits bankruptcy judges to hear and determine core proceedings, §157(c)(1) requires a de novo review of such matters by the district court, and only it can enter a final order. Thus, judicial economy is best served by having the district court first determine the issue.

The fact that the bankruptcy court cannot conduct a jury trial on a noncore matter is also sufficient cause for permissive withdrawal. In re Orion Pictures Corp., 4 F.3d 1095, 1101 (2d Cir. 1993). See also In re Daewoo Motor America Inc., 302 B.R. 308, 315 (C.D. Cal. 2003) (“Thus, where there is a right to jury trial in a noncore matter, that factor may weigh heavily in favor of withdrawing the reference so as to give the parties an opportunity for a jury trial in the district court.”). Where an insurance dispute was “entirely severable from the bankruptcy proceedings” and said dispute involved noncore issues, the district court withdrew the reference. In re Comdisco Inc., No. 04 C 5570, 2004 WL 2674398, at *2 (N.D. Ill. Oct. 15, 2004).1

While cause is not defined in the statute and is a flexible concept, it is not an “empty requirement.” Holmes v. Grubman, 315 F. Supp. 2d 1376, 1381 (M.D. Ga. 2004) (reciting same factors previously described as being applicable in Eleventh Circuit). The moving party bears the burden of demonstrating that both the timeliness and cause requirements of §157(d) have been met. In re Almac’s Inc., 202 B.R. 648, 654 (D. R.I. 1996).

Mandatory Withdrawal
Most courts applying the mandatory withdrawal standard employ a “substantial and material test,” but this phrase has been given a variety of meanings. Some courts utilize this standard in interpreting the term “consideration” under §157(d) and find that mandatory withdrawal is required only if the proceedings cannot be resolved without “substantial and material consideration of nonbankruptcy laws.” In re G-I Holdings Inc., 295 B.R. 211, 221 (D. N.J. 2003).

The Seventh Circuit stated that the substantial and material test really refers to the necessary extent of interpretation of the non-title 11 statute or the court’s necessary analysis of “significant open and unresolved issues” and not the mere application of it. In the Matter of Vicars Ins. Agency Inc., 96 F.3d 949, 954 (7th Cir. 1996). Another court has found the substantial and material test to have been satisfied where the nonbankruptcy federal law at issue (domestic patent law) is central to the outcome of the case. In re Singer Co., 01 Civ. 0165 (WHP), 2002 U.S. Dist. LEXIS 2629, at *8 (S.D.N.Y. Feb. 20, 2002). On the other hand, a district court recently denied a motion to withdraw the reference where the issues of federal law presented (FDCPA and RESPA claims) were routinely considered in bankruptcy proceedings and therefore did not require the court’s substantial and material consideration. Prince v. Countrywide Home Loans, No. 1:08-0058, 2008 WL 4572545, at *2 (M.D. Tenn. Oct. 8, 2008).

The District Court for the Southern District of New York appears to use various iterations of the test. In In re Enron Corp., the court looked to whether the examination of the federal law in question would be more than de minimis in deciding to withdraw the reference. No. 04 Civ. 8177 (RCC), 2004 WL 2711101 at *4 (S.D.N.Y. Nov. 23, 2004). In another case, mandatory withdrawal was warranted where a nonbankruptcy federal statute “arguably conflicts” with the Bankruptcy Code. In re Cablevision S.A., 315 B.R. 818, 821 (S.D.N.Y. 2004). This court has also held that “novel or unsettled questions of nonbankruptcy law” do not need to be present to permit the district court to withdraw the reference. In re Enron Corp., 388 B.R. 131, 139 (S.D.N.Y. 2008). While withdrawal is not mandated when consideration of non-Code law “entails only the straightforward application of settled law to the facts of a particular case,” it is required when a significant interpretation of non-Code statute is needed, when a non-Code issue dominates, or when nonbankruptcy federal law governing the case significantly and materially conflicts with relevant bankruptcy law. In re Chateaugay Corp., 193 B.R. 669, 673 (S.D.N.Y. 1996).

As shown by the foregoing, the substantial and material test can have different meanings. The case most likely to lead to withdrawal of the reference under the mandatory withdrawal provision of §157(d) would involve a non-title 11 federal issue that is central to the determination of the case, not regularly ruled on by bankruptcy courts, and presents either an undecided issue under the non-title 11 law or conflicts with bankruptcy policies.

The statutory resolution under §157(d) to the Northern Pipeline constitutional crisis is less than satisfactory because it leaves much uncertainty as to the jurisdictional limits of bankruptcy courts. Uncertainty is inherent in the absence of a clear definition of “cause” and the “substantial and material” overlay attributed to the mandatory withdrawal standard. We can say that timeliness of the motion is critical and that there is much room for advocacy.

The nonanalytical factors associated with motions to withdraw the reference should be recognized but overcome and a careful judgment made as to whether such a motion is likely to succeed. Contrary to initial inclinations and depending on the issues, the bankruptcy court may be as or better equipped than the district court to decide even a noncore issue. The district court should not be concerned about taking all or part of a case from the bankruptcy court, and the bankruptcy court should not be concerned that §157(d) permits or requires a withdrawal of the reference.

1 Interestingly, the same court ruled seven months earlier that, despite the fact that a state law insurance question at issue was noncore, withdrawing the reference was not appropriate because judicial economy and efficiency actually would have been hindered by the withdrawal. In re HA 2003 Inc., No. 3 C 9008, 2004 WL 609799, at *3 (N.D. Ill. March 22, 2004).

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