The Uneasy Relationship Between Arbitration and Bankruptcy.

Date22 December 2022
AuthorHamer, Michelle M.

Bankruptcy law seeks to collect and resolve all disputes against a debtor in one forum, namely the bankruptcy court. Federal arbitration law seeks to enforce agreements to resolve disputes between contracting parties before an arbitrator, and not a judge. Both laws endeavor to promote efficiency in dispute resolution. Yet when they intersect, confusion, delay, and additional costs may result.

Notably, bankruptcy and arbitration laws do not always conflict and, in certain cases, arbitration may streamline the bankruptcy process. However, the relevant statutes and applicable case law struggle to provide clear and consistent guidance. Fortunately, this Symposium brings together an incredi' bly talented group of academics to examine the issues and identify different ways to approach the enforcement of arbitration agreements in bankruptcy.

This Preface first provides some background on the Federal Arbitration Act (the "FAA") (1) and how courts have interpreted the FAA over the years. It then focuses on case law discussing the FAA, arbitration agreements, and the Bankruptcy Code (the "Code"). (2) This section identifies the issues most often at the center of a potential conflict between the FAA and the Code and the different approaches taken by courts to address those issues. Finally, the Preface summarizes the four papers being presented at the Symposium and includes an abstract for each.

  1. ORIGINS OF THE FAA AND CASE LAW DEVELOPMENT

    Prior to the enactment of the FAA, most courts in the United States were reluctant to enforce arbitration agreements. (3) Perhaps they were following the approach of English courts at the time, which viewed arbitration as an attempt to divest the courts of jurisdiction. (4) Perhaps they simply believed that each party was entitled to its day in court. (5) Regardless, the courts' urn willingness to enforce arbitration agreements did not go unnoticed, and Congress stepped in to remedy this perceived problem.

    Congress passed the FAA in 1925, (6) modeled largely after New York's arbitration statute. (7) The FAA defines the rights and remedies of parties to an arbitration agreement (including a contract containing an arbitration clause) and was intended to ensure that such agreements were "valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." (8) In general, the FAA allows a party to an arbitration agreement to request that a court stay litigation concerning the contract and compel arbitration; it gives arbitrators certain powers; and it facilitates the enforcement of arbitral awards. (9)

    1. THE COURTS' GENERAL APPROACH TO THE FAA

      The FAA required courts to look anew at arbitration agreements and their proper role in dispute resolution. Some courts and commentators initially focused on the enforcement of arbitration agreements between "merchants of equal bargaining power" under the FAA. (10) Interestingly, the Supreme Court hinted at this purpose in its early FAA decisions, with dissenting Justices highlighting it more prominently in later cases. (11)

      This initial focus was grounded in the contractual nature of arbitration rights and needs of the commercial marketplace. For example, if two sophisticated parties agree to an arbitration clause, that dispute resolution medianism is arguably factored into the pricing of the contract and should be enforced to provide each party the benefit of its bargain. This approach also aligns with the legislative history of the FAA (12) and the notion that, by enacting the FAA, Congress sought to have courts treat arbitration agreements in the same manner as they would any other contract. (13)

      Over the years, however, the Supreme Court has expanded the reach of the FAA and articulated a federal policy "favoring arbitration." (14) This shift in focus has led to courts enforcing arbitration agreements concerning employment claims and securities claims, as well as arbitration agreements raised in state courts. (15) In several of these instances, courts are arguably enforcing arbitration provisions in contracts involving parties of unequal bargaining power. Whether the FAA does or should extend to contracts of adhesion is subject to debate. (16) Indeed, very few contracts seem to escape the reach of the FAA. (17)

    2. SELECT SUPREME COURT CASES ADDRESSING THE FAA

      A quick review of a few key Supreme Court cases serves to illustrate the general progression of case law interpreting the FAA. It also provides a nice foundation for discussing the intersection of bankruptcy law and arbitration law.

      In its early decisions, the Supreme Court scrutinized whether the subject dispute was covered by the FAA, focusing on the language of section 2 of the FAA and whether the matters involved arbitration agreements in maritime or commerce transactions. (18) In fact, in Bernhardt, the Court rejected the Court of Appeals' suggestion that the reference to maritime and commerce transactions limited the scope of only section 2 of the FAA and that section 3 of the FAA applied to all arbitration agreements. The Court responded, "We disagree with that reading of the Act. Sections 1, 2, and 3 are integral parts of a whole." (19) This led the Court to hold that the employment dispute before it fell outside the scope of the FAA.

      The Supreme Court's language concerning the purpose of the FAA was more reserved in its early cases. For example, in Wilko v. Swan, the Court stated that "[t]he United States Arbitration Act establishes by statute the desirability of arbitration as an alternative to the complications of litigation." (20) It also suggested that the FAA might not apply in disputes involving parties of unequal bargaining power. With respect to the securities margin contract at issue in Wilko, the Court observed, "While a buyer and seller of securities, under some circumstances, may deal at arm's length on equal terms, it is clear that the Securities Act was drafted with an eye to the disadvantages under which buyers labor." (21) Considering the relevant provisions of statutes before it, the Court concluded that a waiver of forum prior to an actual dispute was prohibited by the Securities Act. (22) The Court therefore found the arbitration provision in the margin agreement invalid.

      Notably, the Supreme Court overruled Wilko in 1989, (23) but the shift in the Court's approach to the FAA started in a very gradual manner prior to that time. (24) Although several cases might demonstrate this shift, the Supreme Court's decision in Prima Paint Corp. v. Flood & Conklin Manufacturing Co., is useful because it articulates some of the Court's prior reasoning while starting to expand the reach of the FAA. (25) In Prima Paint, the primary issue was whether the parties' dispute over the validity of a consulting agreement was subject to arbitration. The United States Court of Appeals for the Second Circuit held that it was, opining that the arbitration provision could be severed from the consulting agreement and enforced as to the parties' fraud in the inducement claim. The Supreme Court affirmed.

      In reaching its decision, the majority opinion first analyzed whether the consulting agreement was covered by section 2 of the FAA. It found the agreement to be related to commerce and, in a footnote, reiterated the suggestion set forth in Wilko and other cases that "categories of contracts otherwise within the Arbitration Act but in which one of the parties characteristically has little bargaining power are expressly excluded from the reach of the Act." (26) The Court then considered whether the parties' dispute concerning the validity of the agreement nevertheless removed the consulting agreement from the scope of the FAA. The majority said no, holding that so long as the arbitration provision is valid, the federal courts must enforce that provision, even if the validity of the contract itself is at issue. (27)

      The dissent in Prima Paint strongly disagreed with the majority on several grounds, including whether the consulting agreement was governed by the FAA. (28) According to the dissent, sections 2 and 3 of the FAA "were plainly designed to protect a person against whom arbitration is sought to be enforced from having to submit his legal issues as to validity of the contract to the arbitrator." (29) From that premise, the dissent notes that "Prima's agreement to an arbitration clause in a contract obtained by fraud was no more Voluntary' than an insured's or employee's agreement to an arbitration clause in a contract obtained by superior bargaining power." (30) The dissent then goes on to criticize the majority's adoption of the severability rule and displacement of state law with federal arbitration law in diversity cases. (31)

      The differing perspectives on the FAA articulated in Prima Paint to some extent foreshadowed the policy debate and analysis shift that emerged in later Supreme Court decisions. For example, the Court's subsequent FAA decisions not only overruled or limited its prior rulings, but also framed the discussion differently. The Supreme Court (and, in turn, lower courts) began describing the FAA as establishing "a 'federal policy favoring arbitration,' ... [and] requiring that 'we rigorously enforce agreements to arbitrate.'" (32) In McMahon, the Court upheld the arbitration of claims under the Exchange Act and RICO, (33) and distinguished both from the Securities Act claims at issue in Wilko. (34)

      Although the Court in McMahon enforced the FAA in the context of other statutory claims, it did not establish a per se rule. Rather, the Court set forth a multi-factor test to evaluate the competing federal statutes before it and, in turn, assist lower courts facing similar issues. The Court explained this analysis as follows,

      The Arbitration Act, standing alone, therefore mandates enforcement of agreements to arbitrate statutory claims. Like any statutory directive, the Arbitration Act's mandate may be...

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