The extent to which arbitration agreements are enforceable in bankruptcy is a question not yet resolved in the Supreme Court. Bankruptcy Judge Randal S. Mashburn of Nashville, Tenn., nipped off one of the questions by holding that a debtor cannot fend off an involuntary petition by demanding arbitration to resolve the validity of the claims of the petitioning creditors.
In his October 7 opinion, Judge Mashburn left the door open for a later ruling that the creditors might be compelled to arbitrate the validity of their claims.
The Involuntary and the Demand for Arbitration
The debtor and three creditors were involved in a construction project. The contracts between the debtor and each of the three creditors contained a similar arbitration clause.
The three creditors banded together and filed an involuntary chapter 7 petition under Section 303. Pointing to the arbitration agreement, the debtor responded to the petition by moving the bankruptcy court to dismiss the petition or abstain pending the outcome of arbitration over the validity of the creditors’ claims.
Judge Mashburn decided that he would first rule on the motion to dismiss or abstain in view of the arbitration and agreement and hold a trial later on the involuntary petition, should he deny the dismissal or abstention motion.
‘Inherent Conflict’
Tackling the demand for arbitration regarding the validity of the claims, Judge Mashburn began with the proposition that federal law favors arbitration under the Federal Arbitration Act. He cited Shearson/American Express Inc. v. McMahon, 482 U.S. 220 (1987), for holding that arbitration agreements must be upheld absent an inherent conflict between arbitration and the underlying purpose of another federal statute.
Judge Mashburn cited the Second, Third, Fourth, Ninth and Eleventh Circuits for holding that Congress did not intend for the Bankruptcy Code “as a whole” to conflict with the FAA. The Sixth Circuit, he said, has not taken a position.
To decide whether there is an “inherent conflict” on an involuntary petition, Judge Mashburn said that “courts typically first determine” whether the subject of arbitration would be core or noncore in bankruptcy court. Of course, he ruled that the issue was core.
Next, Judge Mashburn addressed the question of whether there is an inherent conflict between the Bankruptcy Code and arbitration when it comes to adjudicating issues involved in an involuntary petition.
Regarding inherent conflict, Judge Mashburn said that the bankruptcy court is the only forum for adjudicating an involuntary petition. If the question were referred to arbitration, he said that the arbitrator “could not enter” an order for relief. To do so, he said, “would be delegating to an arbitrator a question over which Congress intended that bankruptcy courts have exclusive jurisdiction.”
“By requiring that bankruptcy cases be commenced by the filing of a petition in a bankruptcy court,” Judge Mashburn held that “Congress clearly intended bankruptcy courts to have the exclusive jurisdiction to evaluate and rule on the validity of such a petition.” He said there is an inherent conflict between the Bankruptcy Code and arbitration on the eligibility of petitioning creditors and the entry of an order for relief.
Judge Mashburn deflected the debtor’s argument that he would intrude on the purview of the arbitrator by evaluating the validity of the creditors’ claims. In ruling on the involuntary petition, the judge said he would not be deciding on the validity of the creditors’ claims, only on whether there was a bona fide dispute. He rejected the idea that the bankruptcy court must first allow arbitration to determine the validity of the creditors’ claims before ruling on the involuntary petition and whether the creditors hold claims subject to a bona fide dispute.
In that respect, he said that “a creditor cannot contract away its right as a petitioner in an involuntary case any more than a debtor can contract away its right to file a voluntary bankruptcy.”
Judge Mashburn denied the debtor’s motion “to the extent it seeks dismissal or abstention based on the arbitration agreements,” but he was not through.
Judge Mashburn was careful to say that he was “making no determination at this time regarding whether arbitration should be used at some point in resolving disputes over the claims in the event an order for relief is entered.” Ruling on the allowance of the claims, he said, raises “numerous variables . . . — some requiring further legal analysis and some based more on practical considerations.”
The extent to which arbitration agreements are enforceable in bankruptcy is a question not yet resolved in the Supreme Court. Bankruptcy Judge Randal S. Mashburn of Nashville, Tenn., nipped off one of the questions by holding that a debtor cannot fend off an involuntary petition by demanding arbitration to resolve the validity of the claims of the petitioning creditors.
In his October 7 opinion, Judge Mashburn left the door open for a later ruling that the creditors might be compelled to arbitrate the validity of their claims.