International arbitration in bankruptcy proceedings: uncertainty in the enforcement of arbitration agreements.

• Author: Howard, David

ARBITRATION agreements are becoming more the norm, especially in international transactions. (1) International arbitration courts like the ICSID and the international Chamber of Commerce have shown a steady, continuing increase in international arbitration cases. (2) As arbitration clauses become more prevalent in contracts, bankruptcy courts will often have to determine if to submit a claim in bankruptcy court to arbitration, as arbitration clauses are generally broad, encompassing "all disputes arising out of or in connection with" that contract. (3) International transactions can be enormous, even involving states, and bankruptcy remains a prevalent issue. (4) zzzz What bankruptcy courts are required to do is still uncertain in the United States. The Supreme Court has not addressed this issue, and there is some variation between circuits. Generally, bankruptcy courts tend to refuse enforcement of an arbitration agreement when arbitration would "inherently conflict" with the purposes of the Bankruptcy Code. But some courts rely heavily on the core/non-core distinction in bankruptcy claims in determining if the arbitration agreement should be enforced, while others only focus on the "inherent conflict" between purposes of the Bankruptcy Code and FAA. The trend by the Supreme Court seems to be in limiting the power of the bankruptcy court under Article III, (5) while broadly enforcing international arbitration agreements in general, even when the dispute involves statutory rights. International arbitration agreements rely on predictability in resolving the disputes and providing a neutral forum for the dispute, protecting the rights of all parties. This article discusses the increasing trend by courts to enforce arbitration agreements unless they conflict with the Bankruptcy Code's purpose, and analyzes new issues that may affect bankruptcy courts' determinations. In international arbitration agreements, even in the context of bankruptcy proceedings, these agreements should be enforced more rigorously than domestic arbitrations to remain in line with the Supreme Court's recent jurisprudence and protect the rights of all international parties.

1. Conflicting Purposes

   Bankruptcy and arbitration are often at odds in their purpose. "[T]he purposes of the Bankruptcy Code include '[centralization of disputes concerning a debtor's legal obligations'" and "protect[ing] creditors and reorganizing debtors from piecemeal litigation'" (6) while arbitration can disrupt this purpose because it can "permit[] an arbitrator to decide a core issue would make debtor-creditor rights 'contingent upon an arbitrator's ruling' rather than the ruling of the bankruptcy judge assigned to hear the debtor's case.'" (7) In bankruptcy, efficient decisions of claims and conserving of the bankrupt estate's assets are fundamental to the purposes of the Bankruptcy Code. (8) However, arbitration has the potential to last much longer and can affect the rights of creditors, presenting what many courts view as "legitimate concerns." (9) The Bankruptcy Code and the FAA may even "present a conflict of near polar extremes: bankruptcy policy exerts an inexorable pull towards centralization while arbitration policy advocates a decentralized approach towards dispute resolution." (10) Arbitration may also present piecemeal litigation concerns as well, especially as some courts will distinguish between "core" and "non-core" issues, discussed below.

   But, in the context of international arbitration, the benefits and purposes of international arbitration may outweigh the costs that arbitration imposes on bankruptcy. Many of the cases discussed below are domestic arbitration cases, but in the context of international arbitration a court should be more willing to compel arbitration. A U.S. bankruptcy court has discretion to compel or not compel arbitration in either a core or non-core proceeding, but there is a greater tendency to compel arbitration where international arbitration is involved. (11)

2. Current Law for Compelling International Arbitration in Bankruptcy Cases

   Arbitration agreements are usually broadly drafted, frequently stating that "All disputes arising out of or in connection with the present contract shall be finally settled under [arbitration]." (12) This clause would normally encompass any bankruptcy issue, so long as the issue relates to the contract that arbitration was sought to enforce. So why do courts consider the issue whether to let bankruptcy claims go to arbitration?

   Since the codification of the New York Convention in the FAA, the Court has moved increasingly in favor of compelling arbitration, even when the matters at issue implicate statutory rights. (13) Scherk v. AlbertoCulver, for example, involved a securities law claim, and the party objecting to arbitration argued that the dispute was not arbitrable under U.S. policy. (14) The Supreme Court dismissed this claim and held that claims involving securities may be submitted to international arbitration. Because the agreement at issue was strictly an international arbitration agreement, the policies and concerns are different than domestic arbitration. Similarly, Mitsubishi Motors Corp. v. Soler ChrysIer-PIymouth (15) involved antitrust claims. Even though these were statutory rights, the court held that these claims could still be submitted to arbitration. (16) The Court held broadly that "any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration," (17) providing a strong presumption of compelling arbitration.

   The underlying three-prong test for when a court will compel arbitration was developed in Shearson/American Express, Inc. v. McMahon. (18) The Court held that even though there is a strong federal policy under the FAA, the "Act's mandate may be overridden by a contrary congressional command." (19) The party seeking to avoid arbitration has the burden of showing that Congress "intended to preclude a waiver of judicial remedies for the statutory rights at issue," which comprises the three part test. (20) To override the FAA, party must show the congressional intent to prohibit arbitration for a particular claim from: (1) the statute's text; (2) statute's legislative history; or (3) an inherent conflict between arbitration and the statute's underlying purposes. (21)

   Courts that have applied McMahon to the intersection of bankruptcy and arbitration have found little to no guidance in the Bankruptcy Code's text or legislative history that would preclude operation of arbitration clauses. (22) In 1991, the Third Circuit addressed this question directly in Hays v. Merrill Lynch. In Hays, the trustee in a Chapter 11 bankruptcy proceeding brought suit against Merrill Lynch, alleging that Merrill Lynch had improperly invested and breached its fiduciary duty. Merrill Lynch filed for arbitration under its arbitration clause in its customer agreement contract. (23) The Third Circuit ultimately held that there were "no provisions in the text of the bankruptcy laws...suggesting that arbitration clauses are unenforceable in a non-core adversary proceeding." (24) Because "Hayes [did] not show that it would be substantial enough to override the policy favoring arbitration," the Court determined the bankruptcy court could not deny enforcement of the arbitration clause. (25) Similarly, the Eleventh Circuit determined that there is "no evidence within the text or in the legislative history that Congress intended to create an exception to the FAA in the Bankruptcy Code." (26) These holdings essentially make the first two prongs of the McMahon test irrelevant in the bankruptcy context regarding compelling arbitration.

   As a result of this precedent, courts have only focused on the third prong of the McMahon test, whether arbitration of the bankruptcy dispute creates an "inherent conflict" with the purpose or policies of the Bankruptcy Code. (27) When an arbitration agreement is invoked, a bankruptcy court cannot deny its enforcement unless the party opposing arbitration can show congressional intent to preclude waiver of judicial remedies for the statutory rights at issue. (28) In general, bankruptcy courts do not have discretion to refuse enforcement of arbitration agreement in non-core proceedings. (29) But in core proceedings, a bankruptcy court can refuse enforcement of an arbitration agreement when it would create a conflict between the purposes of the Bankruptcy Code and the FAA. (30) Increasingly, however, courts have enforced arbitration clauses in the context of core proceedings based on the purposes of the Bankruptcy Code.

   1. Core/Non-Core Distinction

      "Core proceedings include matters arising under the Code or arising in a case under the Code." (31) Section 157(b)(2) of the Bankruptcy Code gives a nonexclusive list of the matters considered core proceedings, including objections to a creditor's proof of claim, preference actions, counterclaims against persons filing claims against the estate, and challenges to the automatic stay or to the discharge of debts. (32) Matters that do not raise bankruptcy issues, such as breach of contract or fraud, are considered non-core. (33)

      In Matter of Nat'l Gypsum Co., (34) the Fifth Circuit declined to rely solely on the core/non-core distinction because it did not accurately reflect the Supreme Court precedent and, while workable, was too broad a test. (35) Not all core bankruptcy proceedings conflicted with the FAA, "nor would arbitration of such proceedings necessarily jeopardize the objectives of the Bankruptcy Code." (36) Instead of relying on the core/non-core distinction, the court should look to the "nature of proceeding, including whether proceeding derives exclusively from provisions of Bankruptcy Code and, if so, whether arbitration of proceeding would conflict with purposes of Code," following the third prong of McMahon. (37) If the arbitration would result in prejudice of creditors and...