Bankruptcy Litigation Committee

ABI Committee News

 

Enforcing Arbitration Clauses in Bankruptcy after Stern v. Marshall

It is well settled based on U.S. Supreme Court decisions applying the Federal Arbitration Act (FAA) that whether arbitration clauses will be enforceable concerning bankruptcy claims will depend on whether the Bankruptcy Code’s underlying policies conflict with the FAA.[2] Many courts have held that the key inquiry in deciding this issue is whether the claim is core or noncore and whether the bankruptcy court may constitutionally enter a final judgment on the claim.[3]

The Court’s ever-controversial decision in Stern v. Marshall,[4]which called into question the bankruptcy courts’ constitutional authority to enter final judgments on certain claims, may impact whether bankruptcy courts may submit bankruptcy claims to arbitration. Courts have differed concerning Stern’s meaning, with many bankruptcy courts finding that Stern had a narrow holding.[5] For example, the bankruptcy court for the Southern District of New York held “[n]owhere in Marathon, Granfinanciera or Stern does the Supreme Court rule that the bankruptcy court may not rule with respect to state law when determining a proof of claim in the bankruptcy, or when deciding a matter directly and conclusively related to the bankruptcy.”[6] The court explained that when adjudication of a proof of claim in bankruptcy is at issue, the bankruptcy court has jurisdiction.[7] Additionally, the court focused on the fact that “Stern is replete with language emphasizing that the ruling should be limited to the unique circumstances of that case.”[8]

Other courts have held that Stern has the effect of removing “certain claims from ‘core bankruptcy jurisdiction,’ and…relegat[ing] them to the category of claims that are merely ‘related-to’ bankruptcy proceedings and thus subject to being heard, but not finally decided, by bankruptcy courts.”[9] In one such case, the chapter 7 trustee sought to recover fraudulent transfers made by the debtor to American Express that were allegedly the result of fraud perpetrated by the debtor’s former officers.[10] The bankruptcy court held that because the trustee’s claims were “quintessentially suits at common law,” the “Stern Court made [it] clear that the Bankruptcy Court lacks constitutional authority to enter final judgment on the claims presented here.”[11]

Similarly, the Seventh Circuit quoted Stern and Marathon when it held that “[w]hen a suit is made of ‘the stuff of the traditional actions at common law tried by the courts at Westminster in 1789,’ and is brought within the bounds of federal jurisdiction, the responsibility for deciding that suit rests with Article III judges in Article III courts.”[12] Therefore, the Seventh Circuit held the bankruptcy court lacked the authority to enter a final judgment on the debtors’ claim that a creditor violated Wisconsin’s medical record confidentiality law.[13] Furthermore, the bankruptcy court did not have jurisdiction over the state law claim simply because the creditor filed a proof of claim in the bankruptcy court.[14]

A case from the U.S. Bankruptcy Court for the Eastern District of North Carolina provides an example of how bankruptcy courts may, after Stern, consider claims subject to arbitration.[15] D&B Swine Farms Inc. filed for chapter 12 on April 6, 2009.[16] On June 30, 2009, D&B filed an adversary proceeding against Murphy–Brown LLC and Smithfield Foods Inc. alleging wrongful termination of a “sow agreement,” and breach of contract and anticipatory repudiation concerning certain “nursery and finishing agreements.”[17] On Sept. 30, 2009, Murphy–Brown and Smithfield moved to compel arbitration because the sow and nursery agreements contained arbitration clauses.[18] The court denied the defendants’ motion to compel arbitration of the nursery agreement because D&B’s breach of contract and anticipatory repudiation claims were core proceedings and therefore held that the arbitration clause was unenforceable as to such claims.[19] The court also held that the sow agreement was not arbitrable because arbitrating D&B’s wrongful termination claim—even though it was a non-core proceeding—“would run exactly counter to the primary goal of a chapter 11 proceeding, which is to efficiently rehabilitate the debtor.”[20]

In late 2011, after Stern was issued, the bankruptcy court reconsidered under Stern whether D&B’s claims were subject to arbitration.[21] The court held that “[i]n light of the ruling in Stern, a state common law action against a defendant who filed no claim for breach of contract to augment the estate—whether the breach occurred pre- or post-petition—must be classified as a non-core proceeding.”[22] Citing White Mountain,[23] the bankruptcy court held whether a proceeding is a “core proceeding” generally determines whether a court may enforce an arbitration clause and since Stern dictated that the claims in this case were noncore, Stern required the bankruptcy court to reverse its previous decision and submit the claims relating to the sow and nursery agreements to arbitration.[24]

As in D&B, if a bankruptcy court may no longer constitutionally enter a final judgment on a certain bankruptcy claim, bankruptcy courts may then be more likely to enforce arbitration clauses with respect to such claims because in keeping with Stern, claims subject to arbitration are unlikely to implicate the Bankruptcy Code’s underlying purpose of providing a centralized forum to adjudicate bankruptcy claims.[25] As courts continue to grapple with Stern, bankruptcy courts may be more apt to submit bankruptcy claims to arbitration if the courts determine that certain bankruptcy claims are non-core.

 


1. The author is a judicial bankruptcy clerk to Hon. H. Christopher Mott for the 2012-13 term.

2. See Shearson/Am. Exp. Inc. v. McMahon, 482 U.S. 220, 226-27 (1987) (holding that court may override FAA’s mandate to enforce an arbitration clause when Congress expressed contrary command in other statute’s text or legislative history, or if arbitration inherently conflicts with statute’s purposes); see also CompuCredit Corp. v. Greenwood, 132 S.Ct. 665, 669 (2012) (reaffirming McMahon test); Hays & Co. v. Merrill Lynch, Pierce, Fenner & Smith Inc., 885 F.2d 1149, 1150 (3d Cir. 1989) (applying McMahon test to bankruptcy and holding that Bankruptcy Code does not express contrary intent to FAA with regard to noncore claims); see also Irve J. Goldman, "Clash of the Statutory Titans: Federal Arbitration Act vs. Bankruptcy Code,” ABI Bankruptcy Litigation Committee Newsletter, Vol. 8, No. 4, June 2011.

3. In re White Mountain Mining Co. LLC, 403 F.3d 164, 169 (4th Cir. 2005) (“Arbitration is inconsistent with centralized decision-making because permitting 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.”); In re U.S. Lines Inc., 197 F.3d 631, 640-41 (2d Cir. 1999) (holding that although core vs. noncore distinction was not dispositive, Code’s intent to provide for centralized court for bankruptcies is stronger in core proceedings, and thus bankruptcy court was within its discretion to refuse to refer declaratory judgment action to arbitration).

4. 131 S.Ct. 2594 (2011).

5. See, e.g., In re McClelland, 460 B.R. 397, 405 (Bankr. S.D.N.Y. 2011) (“The Court agrees that Stern has a narrow application.”); Eric D. Madden and Brandon V. Lewis,“Cut to the Core: Distilling Recent Decisions Interpreting Stern v. Marshall - Part II,” ABI Bankruptcy Litigation Committee Newsletter, Vol. 8, No. 7, November 2011; see also Picard v. Estate of Madoff, No. 11 MISC. 0379 WHP, 2011 WL 6973824, at *5 (S.D.N.Y. Dec. 22, 2011) (“[T]he Supreme Court’s recent decision [in Stern]does not divest bankruptcy courts of jurisdiction to hear all common law claims.”); cf. In re Ortiz, 665 F.3d 906, 914 (7th Cir. 2011) (holding that bankruptcy court did not have authority to adjudicate debtor’s state law claims).

6. In re Salander O’Reilly Galleries, 453 B.R. 106, 117 (Bankr. S.D.N.Y. 2011).

7. Id.

8. Id. at 115-16.

9. In re Canopy Fin. Inc., 464 B.R. 770, 774 (N.D. Ill. 2011).

10. Id. at 771.

11. Id. at 773. Other courts have similarly held. See In re Teleservices Group Inc., 456 B.R. 318, 338 (Bankr. W.D. Mich. 2011) (“[A]ny judgment that will enter against Huntington in this adversary proceeding must be entered by an Article III judge,” and “Stern forces even the familiar to be examined”); In re Emerald Casino Inc., 459 B.R. 298, 300 (Bankr. N.D. Ill. 2011) (holding that trustee’s claims against defendants were counterclaims to claims defendants made against debtor’s bankruptcy estate and therefore are most likely noncore claims under Stern); In re Palazzola, No. 09-37696, 2011 WL 3667624, at *5 (Bankr. N.D. Ohio Aug. 22, 2011) (“[T]he court concludes that Plaintiffs’ § 1983 claim must be dismissed for lack of subject-matter jurisdiction. It is not a claim that this court can hear and determine under § 157(b) and is not a claim “related-to” Plaintiffs’ bankruptcy case such that the court may ‘hear’ the claim under § 157(c)(1).”).

12. Ortiz, 665 F.3d at 912.

13. Id. at 915.

14. Id. at 914.

15.In re D&B Swine Farms Inc., No. 09-02813-8-JRL, 2011 WL 6013218, at *3 (Bankr. E.D.N.C. Dec. 2, 2011).

16. Id. at *1.

17. Id.

18. Id.

19. Id.

20. Id.

21. Id. at *2.

22. Id.

23. See infra, n. 3.

24. Id. at *3.

25. See supra, n. 2.