Enforcing Arbitration Agreements in Bankruptcy

• Jurisdiction: United States,Federal,California
• Author: Reno Fernandez
• Citation: Vol. 2018 No. 1
• Publication year: 2018

Enforcing Arbitration Agreements in Bankruptcy

Reno Fernandez

Reno Fernandez is a partner with Macdonald Fernandez LLP, focusing on commercial bankruptcy and litigation throughout California. Mr. Fernandez is a member of the Executive Committee of the Business Law Section.

Boston Herald, Sungevity, and RadioShack all have in common that their bankruptcy cases were filed in Delaware, not where the bulk of their creditors or operations were located. The prevailing trend is to file and prosecute large bankruptcy cases in Delaware, New York, and other distant fora. The collapse of brick-and-mortar retail stores already underway will see more large cases filed far away. Litigation involving such debtors may potentially be brought back home pursuant to an applicable arbitration clause, if there is one, but only if that issue is carefully and timely raised in the bankruptcy case. This is one reason among many why it is important to understand the intersection of arbitration and bankruptcy.

Debtors and trustees typically favor litigating claims in bankruptcy court. If the debtor commences a bankruptcy case in the midst of arbitration or before arbitration has begun, the creditor will be faced with the challenge of obtaining relief from the automatic stay (or using another procedural avenue, such as abstention) to allow the arbitration to proceed or obtaining an order compelling arbitration in the first instance and, if necessary, obtaining an order staying any related proceedings in the bankruptcy court pending arbitration. Scenarios in which requests for arbitration are common include: consumer protection litigation (often combined with stay violation claims), rescission claims under the Truth in Lending Act ("TILA"),¹ and insurance disputes.

The Federal Arbitration Act

The Federal Arbitration Act (the "FAA")² generally requires bankruptcy judges to enforce a valid arbitration clause and compel arbitration unless it would conflict with a fundamental purpose of the Bankruptcy Code. § 2 of the FAA provides that:

A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof, or an agreement in writing to submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.

A party may move to stay proceedings pending completion of an arbitration under § 3 of the FAA, and a party may move to compel arbitration under § 4. It is important to note that arbitration clauses were frequently given little attention until the United States Supreme Court clarified that arbitration is a favored proceeding, in Shearson/American Express, Inc. v. McMahon?

Public Policy and Burden

The FAA establishes a policy favoring arbitration agreements.⁴ Courts are required to rigorously enforce arbitration clauses.⁵ A bankruptcy court must enforce an arbitration clause even if arbitration is not the most efficient forum.⁶

A party opposing arbitration bears the burden of showing that Congress intended to preclude arbitration under the circumstances.⁷ In particular, the opponent must establish that Congress intended to preclude a waiver of judicial remedies under the circumstances.⁸

General Principles

The majority of authorities follow an analysis consisting of up to four steps, depending upon how many of the steps are at issue, as follows:

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First, the bankruptcy court determines whether the arbitration clause is valid. This must be done carefully, as a challenge to the entire agreement is subject to arbitration. In Buckeye Check Cashing Inc. v. Cardegna,⁹ a non-bankruptcy case dealing with a consumer protection and usury class action, the Supreme Court ruled that a challenge to the validity of a contract—as distinguished from a challenge to the arbitration clause itself—must be referred to the arbitrator. A decision prior to Buckeye illustrates the distinction: "[w]here there is a general claim that the underlying agreement was fraudulently induced, the court must refer it to arbitration. A claim of fraud in the inducement of the arbitration provision itself, however, should be decided by the federal court."¹⁰ State contract law determines the validity of an arbitration agreement.¹¹ See the discussion, infra, for further authorities regarding challenges to the validity of arbitration clauses.

Second, the court determines whether the parties agreed to arbitrate. Sometimes this is not clear, as in Tittle v. Enron Corp. (In re Enron Corp.),¹² for example, where the insured and the insurer agreed to arbitrate, but the resolution would bind third parties who had not agreed to arbitrate. Accordingly, the arbitration clause was not enforced.

Third, the court determines whether the bankruptcy court has discretion to decline arbitration. This is itself a two-part analysis. First, the court determines whether the matter is core or non-core, the definitions of which are discussed separately, infra. The majority of courts hold that a bankruptcy court lacks discretion to deny arbitration in non-core matters. "We hold that a bankruptcy court must enforce an agreement to arbitrate a claim that is noncore."¹³

In core matters, by contrast, the scope of the court's discretion depends on whether Congress intended to preclude a waiver of judicial remedies for the statutory rights at issue where the Bankruptcy Code conflicts with the FAA. Congressional intent is determined from the language of the Bankruptcy Code, its legislative history, and whether there is an "inherent conflict" between arbitration and the Bankruptcy Code.¹⁴ A court typically focuses upon whether there in an inherent conflict between the Bankruptcy Code and arbitration of the matter at issue. If there is a conflict, the court retains discretion to deny arbitration; if there is no conflict, the court lacks discretion and must compel arbitration. "[E]ven as to core proceedings, the bankruptcy court will not have discretion to override an arbitration agreement unless it finds that the proceedings are based on provisions of the Bankruptcy Code that 'inherently conflict' with the Arbitration Act or that arbitration of the claim would 'necessarily jeopardize' the objectives of the Bankruptcy Code."¹⁵

Fourth (but sometimes first), the court determines whether the movant waived its right to compel arbitration. "A contractual right to arbitrate may be waived expressly or implicitly."¹⁶ For example, in Lewallen v. Green Tree Servicing LLC,¹⁷ the chapter 13 debtor commenced a consumer protection action against a mortgage lender as a counterclaim to the lender's proof of claim. The lender moved to compel arbitration, and the bankruptcy court ruled that the lender waived arbitration by filing a proof of claim and participating in the litigation.

Although most courts frame the test as a stepwise analysis, focusing on whether the underlying issue is core or non-core, the author of these materials suggests that these concepts are only guides, and that the proper test is whether arbitration would conflict with a significant objective of the Bankruptcy Code, regardless of whether the matter is core or non-core. Nevertheless, decisions turning upon the distinction between core and non-core matters cannot be ignored.

Core v. Non-Core

Pursuant to 28 U.S.C. § 151(b)(1), bankruptcy judges are empowered to hear and determine all bankruptcy cases, as well as all core proceedings arising under the Bankruptcy Code ("arising under" jurisdiction) or arising in a bankruptcy case ("arising in" jurisdiction). Although beyond the scope of these materials, it is important to note that the bankruptcy court's constitutional authority to enter final orders in core matters is subject to significant constitutional limits that are not reflected in the statute.¹⁸ A non-exclusive list of core matters is provided in 28 U.S.C. § 151(b)(2), which is as follows:

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(A) matters concerning the administration of the estate;
(B) allowance or disallowance of claims against the estate or exemptions from property of the estate, and estimation of claims or interests for the purposes of confirming a plan under chapter 11, 12, or 13 of title 11 but not the liquidation or estimation of contingent or unliquidated personal injury tort or wrongful death claims against the estate for purposes of distribution in a case under title 11;
(C)counterclaims by the estate against persons filing claims against the estate;
(D) orders in respect to obtaining credit;
(E) orders to turn over property of the estate;
(F) proceedings to determine, avoid, or recover preferences;
(G) motions to terminate, annul, or modify the automatic stay;
(H) proceedings to determine, avoid, or recover fraudulent conveyances;
(I) determinations as to the dischargeability of particular debts;
(J) objections to discharges;
(K) determinations of the validity, extent, or priority of liens;
(L) confirmations of plans;
(M) orders approving the use or lease of property, including the use of cash collateral;
(N) orders

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