Bankruptcy Litigation Committee

ABI Committee News

The Enforceability of Arbitration Clauses in Core Bankruptcy Matters

The Second and Third Circuits recently issued opinions that support the enforceability of otherwise valid arbitration clauses in core bankruptcy matters. The opinions also highlight a circuit split regarding the appropriate legal standard to be used to determine whether bankruptcy courts have discretion to refuse to enforce arbitration clauses in core matters. In the Second and Fourth Circuits, bankruptcy courts have discretion to refuse to enforce arbitration clauses in core matters if the dispute is based on Bankruptcy Code provisions and arbitration would inherently conflict with the purposes of the Code or if arbitration of the dispute would necessarily jeopardize the objectives of the Code. See MBNA America Bank N.A. v. Hill, 436 F.3d 104, 110 (2d Cir. 2006); Philips v. Congelton L.L.C., (In re White Mountain Mining Co.), 403 F.3d 164, 170 (4th Cir. 2005). In the Third and Fifth Circuits, bankruptcy courts have such discretion only if the dispute is based on Code provisions and arbitration would inherently conflict with the purposes of the Code. See Mintze v. American Gen. Fin. Serv. Inc. (In re Mintze), 434 F.3d 222, 231 (3d Cir. 2006); Gandy v. Gandy (In re Gandy), 299 F.3d 489, 495 (5th Cir. 2002). 

MBNA America Bank N.A. v. Hill
In Hill, the chapter 7 debtor asserted a putative class action against a lender arising from alleged willful violations of the automatic stay under §362(h) based on a post-petition withdrawal from the debtor’s bank account. See Hill, 436 F.3d at 106. The lender moved to dismiss or stay the adversary proceeding in favor of arbitration. See id. The bankruptcy court denied the lender’s motion, and the district court affirmed the bankruptcy court’s decision. See id. at 107. The Second Circuit reversed the lower courts and held that the bankruptcy court did not have discretion to refuse to enforce the arbitration clause because arbitration of the dispute did not inherently conflict with the Code or necessarily jeopardize the objectives of the Code. See id. at 110. 

The Second Circuit began its analysis by noting that bankruptcy courts have discretion to refuse to enforce arbitration clauses in core matters if Congress intended to preclude arbitration of the dispute at issue and that such “congressional intent can be deduced from the statute’s text or legislative history, or from ‘an inherent conflict between arbitration and the statute’s underlying purposes.’”  Id. (quoting Shearson/Am. Exp. Inc. v. McMahon, 482 U.S. 220, 227 (1987)). After stating the well-accepted principle that bankruptcy courts generally do not have discretion to refuse to enforce arbitration clauses in noncore matters, the Second Circuit held that bankruptcy courts only have such discretion in core matters if “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.” Hill, 436 F.3d at 108 (citing U.S. Lines Inc. v. Am. S.S. Owners Mut. Prot. & Indem. Ass’n. Inc. (In re U.S. Lines Inc.), 197 F.3d 631, 640 (2d Cir. 1999)). The Second Circuit then stated:

    This determination requires a particularized inquiry into the nature of the claim and the facts of the specific bankruptcy.  The objectives of the Bankruptcy Code relevant to this inquiry include the goal of centralized resolution of purely bankruptcy issues, the need to protect creditors and reorganizing debtors from piecemeal litigation, and the undisputed power of a bankruptcy court to enforce its own orders. 
Hill, 436 F.3d at 108 (internal citations omitted). 

The Second Circuit’s holding is similar to the Fourth Circuit’s holding in White Mountain Mining. See White Mountain Mining, 403 F.3d at 170. Thus, as in the Fourth Circuit, Second Circuit bankruptcy courts have discretion to refuse to enforce arbitration clauses even if the proceedings are not based on Code provisions if the dispute necessarily jeopardizes the goals of the Code, such as by substantially affecting a debtor’s ability to reorganize or the recoveries of creditors. See U.S. Lines, 197 F.3d at 635 (refusing to enforce arbitration clause in dispute regarding insurance policies); White Mountain Mining, 403 F.3d at 167 (refusing to enforce arbitration clause in dispute regarding whether pre-petition advances were loans or capital contributions).

Mintze v. American General Financial Services Inc. (In re Mintze)

In Mintze, the chapter 13 debtor attempted to enforce an alleged pre-petition rescission of a loan agreement. See Mintze, 434 F.3d at 226. The lender moved to compel arbitration of the dispute.  See id. The bankruptcy court denied the lender’s motion and the district court affirmed the bankruptcy court’s decision. See id. at 227. The Third Circuit reversed the lower courts and held that the bankruptcy court did not have discretion to refuse to enforce the arbitration clause because the proceedings were not based on Code provisions and Congress did not intend to preclude a waiver of the statutory rights at issue. See id. at 231. This holding reversed numerous opinions within the Third Circuit, which held that bankruptcy courts generally have discretion to refuse to enforce arbitration clauses in all core matters. See, e.g., SFC New Holdings Inc. v. The Earthgrains Co., (In re GWI Inc.), 269 B.R. 114, 117 (Bankr. D. Del. 2001); Sacred Heart Hosp. v. Independence Blue Cross (In re Sacred Heart Hosp.), 181 B.R. 195, 202 (Bankr. E.D. Pa. 1995).

The Third Circuit began its analysis by noting that bankruptcy courts have discretion to refuse to enforce arbitration clauses in core matters if Congress intended to preclude arbitration of the dispute at issue and that such congressional intent “can be discerned in one of three ways: (1) the statute’s text, (2) the statute’s legislative history or (3) an inherent conflict between arbitration and the statute’s underlying purposes.” Id. at 229 (citing McMahon, 482 U.S. at 227). After finding that the first two parts of the legal standard set forth in McMahon were not met, the Third Circuit analyzed the third part and focused on the fact that “the McMahon standard requires congressional intent ‘to preclude a waiver of judicial remedies for the statutory rights at issue.’”  Mintze, 434 F.3d at 231 (quoting McMahon, 482. U.S. at 227). The Third Circuit held that “with no bankruptcy issue to be decided by the bankruptcy court, [the Third Circuit] cannot find an inherent conflict between arbitration of Mintze’s federal and state consumer protection issues and the underlying purposes of the Bankruptcy Code.” Mintze, 434 F.3d at 231. This holding is similar to the Fifth Circuit’s holding in Gandy. See Gandy, 299 F.3d at 495. Thus, as in the Fifth Circuit, Third Circuit bankruptcy courts have discretion to refuse to enforce arbitration clauses only if the proceedings are based on Code provisions and arbitration of the dispute would inherently conflict with the purposes of the Code. See id.; Gandy, 299 F.3d at 495.

As a result, Third and Fifth Circuit bankruptcy courts have discretion to refuse to enforce arbitration clauses in core matters only if the dispute at issue is based on Code provisions and arbitration would conflict with the purposes of the Code, while Second and Fourth Circuit bankruptcy courts have such discretion, even if the dispute is not based on Code provisions, if the dispute necessarily jeopardizes the goals of the Code.