When a trustee objects to the allowance of a claim because it was allegedly usurious under state law, the trustee cannot be compelled to arbitrate the question of usury, according to an opinion by Bankruptcy Judge Benjamin P. Hursh of Butte, Mont.

In his September 30 opinion, Judge Hursh went out of his way to deny the creditor’s arbitration motion under several theories pertinent to the enforceability of arbitration agreements in bankruptcy.

In a chapter 11 case, the creditor filed a secured proof of claim for about $550,000. After the case converted to chapter 7, the trustee filed an adversary proceeding against the creditor. The complaint had several claims.

The complaint alleged that the creditor’s claim was based on a loan agreement that violated Montana’s usury laws. The complaint sought to disallow the claim, declare the loan’s interest rate to be usurious, impose Montana’s statutory penalty for a usurious loan, avoid the creditor’s lien and recover preferences.

The loan agreement contained a provision calling for arbitration of “any dispute.” The creditor filed a motion to compel arbitration.

Basic Law on Arbitration

In deciding whether to compel arbitration in a bankruptcy case, Judge Hursh said that “most courts” begin with Shearson/American Exp., Inc. v. McMahon, 482 U.S. 220, 226 (1987), where the Supreme Court said that the mandate to arbitrate under the Federal Arbitration Act “may be overridden by a contrary congressional command.’” Citing the Third and Ninth Circuits, he said, “Many courts have concluded that there is nothing explicit in either the Code’s text or legislative history that would establish a broad exception for enforcement of arbitration agreements in bankruptcy.”

Citing 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), Judge Hursh said that “courts have considered whether the subject dispute is core or noncore” in deciding whether to compel arbitration. To read ABI’s report on Anderson, click here. He went on to say that other courts consider whether an arbitration agreement is being enforced against a debtor or a trustee. If it’s the trustee, courts examine “whether the trustee is acting independently on behalf of the estate or standing in the shoes of the debtor by asserting a derivative right.”

In the case before him, Judge Hursh said, “Avoidance actions are not derivative of debtor’s rights and not subject to arbitration.” Furthermore, other counts in the complaint, he said, are “components” of the trustee’s claim objection, where the trustee is the representative of the estate.

Because the claim objection was not derivative of the debtor’s rights, Judge Hursh held that “the Trustee is not bound by the arbitration agreement between Debtor and [claim holder].”

Other Reasons to Deny Arbitration

Judge Hursh said that his analysis could have stopped, but he went on to consider whether the trustee’s claims were core or noncore, given how some courts believe there is a “liberal policy” in favor of arbitration.

Under Continental Ins. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 671 F.3d 1001, 1020 (9th Cir. 2012), Judge Thorpe said he was required to consider whether counts in the complaint were core or noncore and whether compelling arbitration would conflict with the “underlying purposes” of the Bankruptcy Code. He cited “existing case law [that] weighs in favor of compelling arbitration if the disputes involve noncore proceedings.”

Judge Hursh decided that the claim objection was a core proceeding even though the basis of the objection was grounded in state law, because noncore issues are subsumed into the claims-allowance process.

Conflict with the Purposes of the Bankruptcy Code

Having decided that the counts in the complaint were core, Judge Hursh inquired as to whether enforcing arbitration would conflict “with the underlying purposes of the Code.”

Judge Hursh quoted Morgan v. Sundance Inc., 596 U.S. 411, 42 S. Ct. 1708, 1713 (Sup. Ct. May 23, 2022), where the Supreme Court said, “The policy is to make ‘arbitration agreements as enforceable as other contracts, but not more so.’ Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404, n. 12 (1967).” To read ABI’s report on Sundance, click here.

Under Sundance, he said that “a prepetition agreement to arbitrate between a debtor and another party should be treated like other contracts and not benefit from favoritism.” He said that the bankruptcy court provides “a detailed alternative to a piecemeal approach” that would prevail if portions of the trustee’s claim objection were sent to arbitration.

Judge Hursh denied the motion to arbitrate, saying that “arbitration represents a piecemeal individualized alternative to the collective claims allowance process favored by the Code.”