District Court Overrides Arbitration on Disputes Regarding Defective Proofs of Claim

A debtor cannot be forced into individual arbitration after filing a class action suit in bankruptcy court alleging that a buyer of defaulted debt violated Bankruptcy Rule 3001, according to District Judge Elizabeth K. Dillon of Roanoke, Va. Judge Dillon upheld Bankruptcy Judge Rebecca B. Connelly of Harrisonburg, Va.

One of these days, the Supreme Court will set down what the limits are on a bankruptcy judge’s ability to override an arbitration agreement. If it turns out that bankruptcy cases are subject to the ordinary rules for commercial litigation, all manner of disputes over claims will end up in arbitration.

The Defective Proofs of Claim

Two chapter 13 debtors filed adversary proceedings against a buyer of defaulted credit card debt. In their class action complaints, they alleged that the creditor violated Bankruptcy Rule 3001 and the federal Fair Debt Collection Practices Act, or FDCPA, 15 U.S.C. § 1692-1692p. Specifically, the debtors contended that the debt collector violated Rule 3001(c)(2)(A) by incorrectly stating in the proofs of claim that the claims did not include interest, fees or other charges. The complaint also alleged that the debt collector did not file itemized statements of the interest, fees and other charges within 30 days of a request by a debtor, in violation of Rule 3001(c)(3)(B).

The bankruptcy court consolidated the two suits. The agreements with the credit card lender contained arbitration clauses.

The debt collector filed a motion to dismiss and a motion to compel the debtors to pursue individual arbitration. Bankruptcy Judge Connelly denied the motion to compel arbitration. She also retained jurisdiction over the FDCPA claims until deciding whether the debt collector had violated the Bankruptcy Rules.

The debt collector appealed both rulings, but Judge Dillon affirmed in an 11-page opinion on August 13.

Judge Dillon’s Ruling

The standard on appeal was somewhat complex. Judge Dillon conducted de novo review on the question of whether the bankruptcy court had discretion to deny arbitration. Were she to conclude that the bankruptcy court had discretion to deny arbitration, then she would review that decision for abuse of discretion.

Judge Dillon recited Fourth Circuit rules on compelling arbitration. To override an arbitration clause, the court must find that Congress demonstrated “an intention to preclude a waiver of judicial remedies for the statutory rights at issue.” Moses v. CashCall Inc., 781 F.3d 63, 71 (4th Cir. 2015). The requisite intent may be found in the statutory text, legislative history or “an inherent conflict between arbitration and the statute’s underlying purpose.” Id.

Judge Dillon said that the status of claims as core or non-core is “[i]mportant but not dispositive.” Again citing Moses, she said that the fundamental question is “whether compelling arbitration for a claim would inherently undermine the Bankruptcy Code’s animating purpose of facilitating efficient reorganization . . . through” centrality of administration.

Adopting Judge Connelly’s analysis, Judge Dillon said that a violation of Rule 3001 “is not a private right of action.” The bankruptcy court, she said, has discretion to enforce the rules “by imposing sanctions if the standards are not met.” In turn, Rule 3001(c) gives the bankruptcy court discretion to bar the admission of evidence if the rule has been violated. The court also has discretion to enforce the rules by the imposition of other sanctions, such as allowance of attorneys’ fees and expenses.

Applying the law to the facts, Judge Dillon concluded that two “animating purposes” of the Bankruptcy Code “would be severely undermined if a distant arbitrator was tasked with the discretion to determine if a creditor should be sanctioned for a Rule 3001 violation.” She was alluding to the “prompt administration of the bankruptcy estate and the centralization of disputes regarding a debtor’s legal obligations.”

Judge Dillon went on to say that Bankruptcy Judge Connelly did not abuse her discretion because “giving an arbitrator supervisory authority over the claims-filing process would substantially interfere with plaintiffs’ efforts to reorganize their financial affairs in bankruptcy.”

Judge Dillon also ruled that Bankruptcy Judge Connelly had not abused her discretion in retaining jurisdiction over the FDCPA claims. In the eyes of Judge Connelly, those claims amounted to deciding whether the debt collector complied with the Bankruptcy Rules.

Because the bankruptcy court had not “definitively ruled” on whether the FDCPA claims should go to arbitration, Judge Dillon said there was no abuse of discretion in retaining jurisdiction pending a ruling on the Rule 3001 issue. She authorized the debt collector to “renew its argument in favor of arbitration [on the FDCPA claims] after the bankruptcy court resolves the Rule 3001 issues.”

The Supreme Court on Arbitration

How the Supreme Court will come down ultimately on arbitration in the bankruptcy context is far from clear. In nonbankruptcy disputes, the high court has been enforcing arbitration clauses to the hilt.

In the Court’s last term, the justices ruled unanimously that a federal court cannot disregard an arbitration clause even if the demand for arbitration is “wholly groundless.” Rather, the judge must submit the arbitrability question to the arbitrator even if the demand for arbitration appears frivolous to the district court. Henry Schein Inc. v. Archer & White Sales Inc., 139 S. Ct. 524, 202 L. Ed. 2d 480 (Sup. Ct. Jan. 8, 2019).

If there were no special rules for bankruptcy, Henry Schein would give arbitrators responsibility for deciding whether they would rule on core bankruptcy issues such as allowances of claims or dischargeability of debts.

Indeed, a bankruptcy court has allowed an arbitrator to rule on the discharge of student loans. See Williams v. Navient Solutions LLC (In re Williams), 564 B.R. 770 (Bankr. S.D. Fla. 2017). On the other hand, the Second Circuit overrode an arbitration agreement by finding a severe conflict with the Bankruptcy Code and allowing a debtor to mount a class action contending that the creditor had violated the discharge injunction. One Bank NA v. Anderson (In re Anderson), 884 F.3d 382 (2d Cir. March 7, 2018), cert. denied Oct. 1, 2018.

However, Anderson and the other circuit decisions overriding arbitration agreements in bankruptcy cases were decided before Epic Systems Corp. v. Lewis, 138 S. Ct. 1612, 1624 (May 21, 2018), where the Supreme Court held that the language of a statute must be “clear and manifest” before a court can disregard an arbitration agreement. Epic was a 5/4 decision, with the justices divided on ideological grounds.

The question comes down to this: Will the Supreme Court find “clear and manifest” language in the Bankruptcy Code allowing bankruptcy courts to disregard arbitration agreements? And if arbitration must proceed regarding some but not all disputes in the bankruptcy court, what is the line of demarcation? Is it core versus noncore? Will it matter if the creditor has filed a claim? What if a creditor files a claim but demands arbitration?

Conceivably, the Supreme Court could hand down a rule where a bankruptcy case will be running in tandem with one or more arbitrations, causing delay and expense for the debtor. Consumer debtors, in particular, may be unable to afford arbitration, and simultaneous arbitrations might kill a chapter 11 reorganization.

The centrality of administration may lead the Supreme Court to exempt bankruptcy from general rules governing arbitrability. On the other hand, the Bankruptcy Code has no explicit exceptions regarding arbitration.

To read ABI’s discussion of Henry Schein, click here.