Incorporating AAA Rules by Reference Won’t Work with Consumers

Bankruptcy Judge John E. Waites, sitting in Columbia, S.C., refused to compel arbitration of “core” bankruptcy issues. Not surprising.

In a case involving a consumer, he also decided that incorporation of the rules of the American Arbitration Association by reference in an arbitration agreement was not a “clear and unmistakable” expression of intent for the arbitrators to rule on the enforceability of the arbitration agreement or the scope of issues to be arbitrated.

The debtor sued an online university in bankruptcy court. He made claims under both the Bankruptcy Code and state law.

Under the Bankruptcy Code, the debtor sought a determination regarding the dischargeability of student loans under Section 523(a)(8) along with bankruptcy claims for abuse of process. Under state law, he lodged allegations that included fraud, negligence and misrepresentation.

The university responded with a motion to compel arbitration based on an enrollment agreement containing a lengthy arbitration clause. The debtor denied that he had signed the agreement. The university contended that the arbitrators must determine whether there was a valid arbitration agreement and whether the debtor’s claims were arbitrable.

In his January 3 opinion, Judge Waites separately examined the bankruptcy and state law claims to determine whether they were arbitrable.

The Bankruptcy Claims

Regarding bankruptcy claims, Judge Waites said the court has discretion to retain “core” claims where arbitration would present an inherent conflict with the Bankruptcy Code. That’s the standard formulation.

With regard to abuse of process, Judge Waites had “little doubt” that delegating authority to arbitrators over “the bankruptcy court’s § 105 authority would inherently conflict with the Bankruptcy Code.” Permitting arbitration, he said, “would undermine the court’s ability to enforce both its own orders and the Bankruptcy Code.”

Judge Waites therefore refused to allow arbitration of any allegations made under Section 105.

On the dischargeability claim, the debtor contended that he satisfied the Brunner standard. Judge Waites refused to require arbitration of dischargeability, saying that arbitration “would pose an inherent conflict with the Bankruptcy Code.

The State Law Claims

With regard to the state law claims, Judge Waites first addressed the question of whether he or the arbitrators should rule on arbitrability. The general rule in the Fourth Circuit allows the federal court to decide so-called gateway issues of whether there was a valid agreement to arbitrate and whether a specific dispute falls within the agreement to arbitrate. However, the Supreme Court has ruled that the parties may delegate gateway issues to arbitrators.

In the Fourth Circuit, an arbitration agreement must show “clear and unmistakable evidence” that the parties delegated arbitrability questions to the arbitrators. Simply Wireless v. T-Mobile US, Inc., 877 F.3d 522, 526 (4th Cir. 2017), abrogated on other grounds by Henry Schein, Inc. v. Archer and White Sales, Inc., 139 S. Ct. 524 (2019).

In the case at bar, the arbitration agreement incorporated the AAA rules by reference. In turn, the AAA rules task arbitrators with ruling on issues of arbitrability. When sophisticated parties have entered into an arbitration agreement, courts allow arbitrators to rule on arbitrability by relying on incorporation of AAA rules by reference.

When an unsophisticated person is a party to an arbitration agreement, the courts are split, Judge Waites said. He came down on the side of the debtor and followed Stone v. Wells Fargo Bank, N.A., 361 F. Supp. 3d 539 (D. Md. 2019).

When “an unsophisticated party [enters into] an adhesion contract that includes an arbitration agreement,” Judge Waites held that “the incorporation of a set of arbitration rules does not alone create clear and unmistakable evidence of an intent for an arbitrator to determine threshold arbitration issues.”

Judge Waites therefore ruled that he would resolve the “threshold arbitrations issues.” He scheduled an evidentiary hearing to decide whether the debtor had signed the arbitration agreement and whether it was unconscionable.