Another Appellate Court Bars Arbitration of ‘Core’ Claims

A district court has held that a creditor may not compel arbitration to determine the allowance of a claim, even if the objection has been coupled with a class action seeking damages for violation of state law.

The October 22 opinion by District Judge David J. Novak of Richmond, Va., also held that the state may intervene on the side of the debtor and seek monetary relief for the citizens of the state.

The Usurious Loan

The debtor had taken down a $1,500 loan from a so-called payday lender. The loan bore interest of 0.75% per day, with a $100 origination fee. The annual percentage rate worked out to 274%.

The loan agreement contained a broadly worded clause requiring individual arbitration of any disputes “arising from or related to” the debt. The clause also purported to bar the debtor from bringing or joining in a class action.

After the debtor filed a chapter 13 petition, the lender filed an unsecured proof of claim for almost $2,800. The debtor filed an objection to the claim a few days before the bankruptcy court confirmed her plan.

Several months after confirmation, the debtor filed an adversary proceeding in bankruptcy court against the lender objecting to allowance of the claim. On behalf of herself and a class consisting of debtors in the court who had similar loans from the lender, the debtor’s complaint contained additional counts alleging that the loan was usurious under Virginia law and violated the federal Fair Debt Collection Practices Act.

Among other relief, the complaint sought disallowance of the claim, damages for violation of state law and the FDCPA, and disgorgement of principal and interest paid to the lender.

Contending that similar loans violated state consumer finance and usury statutes, the Virginia attorney general filed a motion to intervene, together with a proposed complaint seeking to bar the lender from collecting from bankrupts on similar loans. The attorney general also sought restitution for any principal and interest paid by borrowers.

The lender opposed the motion to intervene and filed a motion to compel arbitration. Bankruptcy Judge Kevin R. Huennekens granted intervention and denied the arbitration motion. The district court granted leave to appeal.

No Arbitration of ‘Core’ Claims

Appealing the order denying the motion to compel arbitration, the lender argued that the claims were not core because the debtor was seeking monetary damages including restitution, disgorgement and attorneys’ fees.

Regarding arbitration, District Judge Novak followed Fourth Circuit authority in Moses v. CashCall, 781 F.3d 63 (4th Cir. 2015), where the appeals court held that a bankruptcy court has discretion to refuse arbitration of “core” claims. The judge therefore proceeded to decide whether the debtor’s claims were core or noncore.

Judge Novak concluded that the debtor’s claims were core even though the complaint sought monetary relief for herself and the class, because the claims for monetary relief will be necessarily decided in determining the allowability of claims against similarly situated debtors.

Given that the claims were core, Judge Novak found no abuse of discretion because compelling arbitration would undermine an “animating purpose” of bankruptcy, the centrality of administration.

Intervention

Next, Judge Novak tackled the order allowing the attorney general to intervene under F.R.C.P. 24, made applicable by Bankruptcy Rule 7024. The standard of review on appeal, he said, is “clear abuse of discretion” because decisions to allow or prevent intervention are “particularly deferential.”

The lender only challenged the bankruptcy court’s subject matter jurisdiction over the attorney general’s claims.

Because disallowance of the claims would prevent the lender from collecting unlawful loans from bankrupts, Judge Novak reasoned that the claims arose in title 11 or were related to the case under title 11. He therefore ruled that the bankruptcy court had subject matter jurisdiction under 28 U.S.C. §§ 157 and 1334(d).

Jurisdiction having been established, Judge Novak found no clear abuse of discretion and therefore upheld the order allowing intervention.

Observations

The enforceability of arbitration agreements in bankruptcy is a hot topic that may end up in the Supreme Court if there is a split of circuits.

Last week, we reported Henry v. Educational Finance Service (In re Henry), 18-20809, 2019 BL 399760 (5th Cir. Oct. 17, 2019), where the Fifth Circuit held that the bankruptcy court has discretion not to enforce an arbitration agreement when a debtor initiated a class action contending that a creditor had violated the discharge injunction.

The Fifth Circuit’s opinion is in accord with One Bank NA v. Anderson (In re Anderson), 884 F.3d 382 (2d Cir. March 7, 2018), cert. denied, One Bank NA v. Anderson 139 S. Ct. 144, 202 L. Ed. 2d 35 (Oct. 1, 2018), where the Second Circuit decided that arbitration was not required when the debtor mounted a class suit in bankruptcy court alleging a violation of the discharge injunction.

The lender who lost in Henry may be filing a motion for rehearing en banc. If the Fifth Circuit sits en banc and reverses the three-judge panel, there will be a circuit split giving rise to an attractive petition for certiorari to the Supreme Court.

In recent terms, the Supreme Court has been nearly rabid (although sometimes not unanimous) in enforcing arbitration agreements. Eventually, the high court will lay down rules describing the circumstances, if any, when a bankruptcy court may decline to enforce an agreement to arbitrate.

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

We will not be surprised if the lender takes Judge Novak’s opinion to the Fourth Circuit, because the panel on CashCall was divided, and the applicability of the majorities’ opinions is not free from doubt.