In the bankruptcy context, arbitration, in contrast with mediation, is not often utilized and may be the more unfamiliar alternative dispute resolution (ADR) option for bankruptcy practitioners.
Arbitration, however, and for the reasons set forth below, is a useful tool for dispute resolution, with many worthwhile benefits. In practice, whether an arbitration provision will be enforced by a bankruptcy court is dependent on certain factors, and has been the subject of numerous court decisions, of which the U.S. Supreme Court case of Shearson/American Express v. McMahon (1987) and the more recent Second Circuit decision of Anderson v. Credit One Bank N.A. (2018), may provide useful guidelines.
The Difference Between Mediation and Arbitration
Mediation and arbitration are both ADR methods to resolve disputes without litigation. The primary difference between the two is that, a mediator, unlike an arbitrator, does not have the power to render a decision in a dispute. Rather, a mediator works with the parties to reach a mutually agreed upon resolution. An arbitrator, on the other hand, may not only decide how to resolve the dispute, but may also in certain circumstances issue a binding decision on the parties.
While mediation appears to be the more commonly used and preferred ADR-process in bankruptcy cases, arbitration (like mediation) offers cost-savings benefits, and a speedier resolution of the matter at issue. Other benefits of arbitration include a certain level of privacy/confidentiality, and flexibility in how the arbitration will be handled.
Ultimately, arbitration may offer a solution for parties where, previously, the parties were not successful in working together to reach a mutually-agreeable resolution, but still want to explore options other than litigation.
Enforcement of Arbitration Provisions
The U.S. Supreme Court in McMahon set forth the standard for determining whether an arbitration clause should be enforced. Under the McMahon standard, the Federal Arbitration Act (FAA) policy favoring arbitration may be overridden. However, “[t]he burden is on the party opposing arbitration … to show that Congress intended to preclude a waiver of judicial remedies for the statutory right at issue.” This congressional intent is discernible from
- the text of the statute,
- its legislative history, or
- an inherent conflict between arbitration and the statute’s underlying purpose.
A bankruptcy court, therefore, in evaluating the enforceability of an arbitration clause in a bankruptcy case, would apply the McMahon factors as a starting point in making its determination. Bankruptcy courts addressing this issue have historically distinguished between core and non-core proceedings in order to determine whether there is an inherent conflict with the purposes of the Bankruptcy Code. See Hays & Co. v. Merrill Lynch, Pierce, Fenner & Smith Inc., 885 F.2d 1149 (3d. Cir. 1989) (holding that a bankruptcy court has little discretion to deny arbitration when a non-core matter was involved). More recently, however, this core/non-core distinction has been found to be relevant, but not alone dispositive. See Continental Ins. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 671 F.3d 1011 (9th Cir. 2012).
The U.S. Supreme Court also recently added that a party bears a heavy burden of showing intent that one statute displaces the other, and such intent must be clear and manifest. See Epic Sys. Corp. v. Lewis, 138 S. Ct. 1612 (2018) (emphasis added).
Further illustrative of the above standard is Anderson, a recent case in which the Second Circuit affirmed a denial of a motion to compel arbitration in connection with the debtor’s claimed violation of the discharge injunction under Section 524 of the Bankruptcy Code. The court held that the debtor’s claim of such violation implicated core bankruptcy proceedings and that arbitration would present an inherent conflict with the congressional intent underlying the Bankruptcy Code.
On the particular facts of this case, the Second Circuit found that the defendant’s post-discharge refusal to remove a charge-off notation from the debtor’s credit reports and the arbitration of a claim based on such violation would “seriously jeopardize a particular core bankruptcy proceeding,” and therefore upheld the lower court’s denial of defendant’s motion to compel arbitration.
The FRBP Procedure Permits Court Authorization of Arbitration
To the extent that a bankruptcy court (as in Anderson) rules that an arbitration provision is not enforceable (or even in cases where there is no arbitration provision at issue or being litigated), the parties may still elect to submit the matter to arbitration.
Federal Rule of Bankruptcy Procedure (FRBP) 9019 provides, in pertinent part, “[o]n stipulation of the parties to any controversy affecting the estate the court may authorize the matter to be submitted to final and binding arbitration.” Fed. R. Bankr. P. 9019(c). Bankruptcy Rule 9019(c) therefore permits a bankruptcy court to authorize the use of binding arbitration in a bankruptcy case, pursuant to the parties’ stipulation.
As a result, even when an arbitration clause is found to be unenforceable, or the litigation does not involve a contract with an arbitration clause, the parties should consider, and may nonetheless elect, to stipulate to arbitration as a smart and potentially effective alternative to litigation.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Howard M. Ehrenberg is the president and managing member of SulmeyerKupetz, a premier business, financial restructuring and litigation firm in California.
Claire K. Wu is an associate at SulmeyerKupetz. She is an expert in bankruptcy, business reorganization, restructuring, and other insolvency solutions.