An appeal taken last week to the district court in South Carolina could end up being the vehicle for the Fourth Circuit and then the Supreme Court to decide whether the bankruptcy court must enforce an arbitration agreement when the debtor mounts a class action alleging a violation of the discharge injunction.

Even if a debtor is not compelled to arbitrate a discharge violation, the South Carolina case could produce more authority — one way or the other — about the bankruptcy court’s authority to host a class action.

Typical Facts on a Discharge Violation

A year after the debtor received her chapter 7 discharge, a creditor sent a letter offering her a 35% discount on a discharged debt of about $650. The debtor reopened her chapter 7 case and responded with an adversary proceeding in bankruptcy court alleging that the letter violated the discharge injunction in Section 524(a).

On behalf of a class of debtors in four circuits, the plaintiff sought a declaration that the letter violated the discharge injunction. The complaint also sought disgorgement of whatever the creditor collected from sending the letter to class members.

The credit agreement contained a broadly worded arbitration clause. The creditor filed a motion to dismiss that Bankruptcy Judge David R. Duncan of Columbia, S.C., treated as a motion to compel arbitration.

Judge Duncan denied the arbitration motion in an opinion on June 8. The creditor appealed to the district court on June 19.

Dubious Fourth Circuit Authority

Judge Duncan rested his decision in large part on Moses v. CashCall, Inc., 781 F.3d 63 (4th Cir. 2015), where the Fourth Circuit ruled that a bankruptcy court has discretion to refuse arbitration of “core” claims. 

More particularly, CashCall allowed the bankruptcy court to decide whether a loan bearing 149% interest was void under state law. In other words, the debtor was not compelled to arbitrate a core issue involving the allowance of a claim.

On the other hand, CashCall required arbitration of a noncore claim where the debtor sought damages under state law.

The rationale underpinning CashCall lacks perfect clarity because there were four opinions, including a dissent, among the three circuit judges on the panel.

The Supreme Court’s Allen Opinion on Copyright

To override the arbitration agreement, Judge Duncan needed to find an inherent conflict between the Federal Arbitration Act and the Bankruptcy Code. In finding the conflict, Judge Duncan buttressed his conclusion by reference to a Supreme Court decision in March dealing with state sovereign immunity from copyright claims, Allen v. Cooper, 140 S. Ct. 994 (2020). Allen in turn drew upon Central Virginia Community College v. Katz, 546 U.S. 356 (2006), for an extended discussion of the notion of “bankruptcy exceptionalism.”

Judge Duncan also rested his decision in part on Credit One Bank NA v. Anderson (In re Anderson), 884 F.3d 382 (2d Cir. March 7, 2018), cert denied, 139 S. Ct. 144 (2018), where the Second Circuit refused to compel arbitration of an alleged violation of the discharge injunction. To read ABI’s discussion of Anderson, click here.

However, Judge Duncan issued his decision eight days before the Second Circuit handed down GE Capital Retail Bank v. Belton (In re Belton), 19-648, 2020 BL 221793 (2d Cir. June 16, 2020). In Belton, the Second Circuit again held that a debtor is not required to arbitrate a contempt action alleging that a creditor violated the discharge injunction.

Significantly, though, Belton included dicta suggesting that the bankruptcy court cannot entertain a nationwide class action seeking redress for a discharge violation. To read ABI’s report on Belton, click here.

In other words, the Second Circuit is heading in the direction of allowing the bankruptcy court to override an arbitration agreement to decide whether there has been a discharge violation and, presumably, whether the debtor individually is entitled to damages. Otherwise, a class action in the Second Circuit is off the table.

Judge Duncan’s decision does not mention how the lawsuit is a class action, because the creditor had not yet questioned the permissibility of a class suit. Judge Duncan therefore had no occasion to rule on the issue. His decision should not be seen as blessing class actions. Consequently, the only issue on appeal would seem to be the arbitration agreement, not the debtor’s ability to raise class claims regarding discharge in bankruptcy court.

If the creditor loses on arbitration, the creditor will presumably oppose class certification at a later time. Although two appeals may be required, the case before Judge Duncan may ultimately decide whether the Fourth Circuit will follow the Second Circuit on arbitration and class actions regarding discharge violations. Stay tuned!