Often solicitous of financial institutions caught up in bankruptcy litigation, the Second Circuit nonetheless held that the bankruptcy court properly exercised its discretion by refusing to allow arbitration in a class action alleging a violation of the Section 524 discharge injunction.
The unanimous opinion on March 7, written by Circuit Judge Rosemary S. Pooler, casts doubt on the continuing influence of MBNA America Bank v. Hill, 436 F.3d 104 (2d Cir. 2006). Hill stood for the proposition that a court in the Second Circuit must order arbitration in a class action alleging a willful violation of the Section 362 automatic stay.
The new decision from the Second Circuit came down two days after the Supreme Court issued its opinion in U.S. Bank NA v. The Village at Lakeridge LLC, 15-1509 (Sup. Ct. March 5, 2018), prescribing the standard of appellate review for mixed questions of law and fact. The Second Circuit did not cite Lakeridge and might have stated the standard of review differently had it analyzed the high court’s new authority regarding bankruptcy appeals.
Judge Pooler’s decision picked the winner between two district judges in New York who had reached diametrically opposite results on the same facts. Another winner is Bankruptcy Judge Robert D. Drain of White Plains, N.Y., who made the decision that was upheld by the Second Circuit on March 7.
The Class Action
An individual got a chapter 7 discharge covering credit card debt. Despite the discharge, the credit card lender continued reporting the debt as charged off rather than discharged in bankruptcy. After having received a discharge, the debtor reopened the chapter 7 case and filed a class action in bankruptcy court alleging that the failure to report the debt as discharged was an attempt at bringing pressure to repay the debt and thus violated the discharge injunction under Section 524 of the Bankruptcy Code.
The lender filed a motion to compel arbitration, relying on a provision in the credit card agreement calling for arbitration of “any controversy.” Bankruptcy Judge Drain denied the motion to compel arbitration in May 2015, and the lender took an immediate appeal, permitted by the Federal Arbitration Act.
District Judge Nelson S. Román of White Plains upheld denial of the motion to compel arbitration. Interpreting Hill, he said that a bankruptcy judge has discretion to “override an arbitration agreement” if the lawsuit is a core proceeding based on provisions of the Bankruptcy Code that “inherently conflict” with the Federal Arbitration Act.
Judge Román found the lawsuit to be core, even though it was a class action, because “discharge is clearly a right created by federal bankruptcy law” and all class members were bankrupts. He next held that arbitrating claims under Section 524 “would necessarily jeopardize the objectives of the Bankruptcy Code.”
In Hill, the Second Circuit had compelled arbitration in a class suit alleging a violation of the automatic stay when the debtor had received a discharge, the case had been closed, and the automatic stay was no longer in effect. Judge Román distinguished Hill because the case before him involved the discharge injunction, which is the “central purpose” of bankruptcy and remains in effect “even after the conclusion of the bankruptcy proceedings.”
“[A]rbitration of a discharge violation would jeopardize this central objective,” Judge Román said. To the Hill analysis, Judge Román added a fourth consideration: uniformity. He said that the need for uniformity was “compelling” because there could be “wildly inconsistent” results in arbitration.
In a case decided in October 2015 called Belton v. GE Capital Consumer Lending Inc. (In re Belton), Vincent L. Briccetti reached the opposite result, also interpreting Hill. To read ABI’s discussion of Belton, click here. Judge Briccetti and the Second Circuit both denied motions in Belton for leave to appeal.
As it turns out, the Second Circuit largely adopted Judge Román’s logic, aided by an amicus brief submitted by Professors Ralph Brubaker, Robert M. Lawless and Bruce A. Markell and Tara Twomey of the National Consumer Bankruptcy Rights Center.
Mootness
The Second Circuit considered whether the appeal was moot because the lender was willing to update the credit reports for everyone in the class.
Judge Pooler ruled that the appeal was not moot because “the question presented and the relief sought both remain unsettled.”
The ruling on mootness is significant because the result in Hill turned in part on the creditor’s repayment of debt allegedly collected in violation of the automatic stay. Therefore, a defendant’s ploy like the one in Hill may no longer suffice to kill off an appeal in the Second Circuit.
The Standard of Appellate Review
Next, Judge Pooler dealt with the standard of review, which she said “has been inconsistently or improperly applied by this Court.”
Without citing Lakeridge, which had been decided two days earlier in the Supreme Court, and without analyzing whether the case presented mixed questions of law and fact, Judge Pooler said that the court would conduct de novo review of the core status of the suit. Similarly, she said, the review is de novo regarding the bankruptcy court’s conclusion that arbitration would cause a “severe conflict” with the Bankruptcy Code.
After Lakeridge, appellate courts must decide that review is primarily legal in nature, rather than factual, before concluding that review is de novo. Judge Pooler did not undertake that analysis.
In deciding whether review is de novo or for clear error, Lakeridge tells appellate courts to examine whether review primarily entails a legal or factual analysis. Finding a “severe conflict” between arbitration and the Bankruptcy Code might entail either a legal or factual analysis.
Depending on the particular facts giving rise to the alleged violation of the discharge injunction, appellate review might invoke the plain error rule if the appellate court’s task focuses more on the facts underlying the conclusion of “severe conflict.”
The Merits
Hill taught that the court has discretion to disregard an arbitration agreement if the proceeding is core and presents a “severe conflict” with the Bankruptcy Code. In deciding whether the class plaintiff-debtor in the new cases should have been obliged to arbitrate, Hill therefore provided the legal precedent, but the facts in that case were “easily distinguished,” Judge Pooler said.
Because the creditor conceded that the issue was core, Judge Pooler was only required to analyze whether Congress intended for the statutory right to a discharge to be non-arbitrable, thus giving the bankruptcy court discretion to refuse to compel arbitration.
Judge Pooler said that discharge is the “foundation” and the “central purpose” of bankruptcy. Therefore, arbitrating a claimed violation of the discharge injunction would “seriously jeopardize” the proceeding because (1) the discharge injunction is integral to providing a fresh start, (2) the claim was made in “an ongoing bankruptcy matter,” and (3) the bankruptcy court’s equitable power to enforce its own injunctions is “central to the structure of the Code.”
Perhaps undercutting Hill, Judge Pooler said that the “putative class action does not undermine this conclusion” because the automatic stay in Hill had become moot by closing the debtor’s bankruptcy case.
Attempting to distinguish Hill, Judge Pooler said that violation of the discharge injunction, as opposed to an automatic stay violation, offends “the central goal of bankruptcy,” contrasted with a violation of the automatic stay, which is no longer in effect in a closed case.
Further, Judge Pooler said the discharge injunction was “still eligible for active enforcement,” compared with the automatic stay, which had lapsed. Judge Pooler did not consider that damages could be sought for a violation of the automatic stay by reopening a closed bankruptcy case.
Without citation of authority, Judge Pooler said that the discharge injunction is “enforceable only by the bankruptcy court and only by a contempt citation.” Arbitration therefore presented “an inherent conflict with the Bankruptcy Code,” Judge Pooler said, because “the bankruptcy court alone has the power to enforce the discharge injunction.”
Having found an “inherent conflict,” Judge Pooler quickly concluded that the bankruptcy judge did not abuse his discretion in ruling out arbitration.
What Remains of Hill?
It is at least arguable that Hill should have required Judge Pooler to impose arbitration. Since the Second Circuit was not sitting en banc, her three-judge panel could not overrule Hill.
In Hill, the issue was also core, but the appeals court required arbitration, overruling the two lower courts.
The Hill court concluded that arbitration would not “seriously jeopardize the objectives of the Bankruptcy Code,” in part because the automatic stay “is not so closely related to an injunction that the bankruptcy court is uniquely able to interpret and enforce.” In the March 7 opinion, Judge Pooler neglected to note that the discharge injunction can be raised as an affirmative defense in any court.
Hill also found significance in the fact that the plaintiff’s bankruptcy case had been closed. However, the debtor’s case also had been closed in the appeal before Judge Pooler, but the bankruptcy judge had reopened the case to permit the filing of the class action.
Hill, therefore, may be limited in the future to class actions in district court seeking redress for violations of the automatic stay. Hill might not require arbitration if the debtor alone seeks damages for an automatic stay violation under Section 362(k), and Hill might not apply to a class action in bankruptcy court seeking redress for an ongoing violation of the automatic stay.
The March 7 decision presents an opportunity for the Second Circuit to sit en banc, either to set aside Judge Pooler’s opinion or overrule Hill outright. However, en banc rehearing is exceedingly rare in the Second Circuit. Stay tuned nonetheless.