The Federal Arbitration Act (FAA), 9 U.S.C. §§ 1 – 307, creates a strong federal policy favoring enforcement of arbitration agreements, and the U.S. Court of Appeals for the Fourth Circuit has ruled that the arbitration policies implemented under the FAA are to be “robustly followed.” Accordingly, contractual agreements between private parties to arbitrate a dispute are valid, irrevocable, and enforceable in the absence of grounds at law or in equity that would mandate revocation of a contract.
On the other hand, the Fourth Circuit has noted that under the federal Bankruptcy Code, 11 U.S.C. §§ 101 et seq., Congress intended to grant comprehensive jurisdiction to bankruptcy courts so that they might deal efficiently and expeditiously with all matters connected with a bankruptcy estate. Moses v. CashCall, Inc., 781 F.3d 63, 71 (4th Cir. 2015).
So what happens when the irresistible force of the FAA, mandating rigorous enforcement of arbitration agreements, meets the immovable object of the Bankruptcy Code, designed to centralize in the bankruptcy court disputes over a debtor’s assets and obligations? The answer to this collision under the law, as it would be in physics, is complicated! Depending on the answer, a debtor may be forced to arbitrate its dispute before an arbitration panel, rather than have the matter decided by a potentially more sympathetic bankruptcy court.
The Supreme Court has provided a general framework for resolving a conflict between the objectives of the FAA and any other statute: a party seeking to prevent enforcement of an arbitration agreement must show that Congress has evinced an intention to preclude the party’s waiver of a judicial resolution of the statutory rights involved in the dispute. Such Congressional intent must be deducible from the statute’s text, its legislative history, or “an inherent conflict between arbitration and the statute’s underlying purpose.” Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220, 227 (1987).
In bankruptcy cases, many federal courts, including the Fourth Circuit in CashCall, have looked to whether a dispute is a “constitutionally core proceeding” in analyzing Congressional intent to restrict or require enforcement of an arbitration provision.
Section 157 of title 28 of the U.S. Code (section 157) lists 16 types of proceedings in a bankruptcy case as “core proceedings.” In general, a core proceeding is a matter that arises under the Bankruptcy Code itself or that would not exist but for the pending bankruptcy case. For example, the “allowance or disallowance of claims against the [bankruptcy] estate” and counterclaims by a bankruptcy estate against persons filing claims against the estate are identified as core proceedings. On the other hand, a “non-core” proceeding is a dispute or other matter that would exist notwithstanding the bankruptcy case but that has an effect on the bankruptcy process.
Section 157 gives bankruptcy courts statutory authority to enter a final judgment in a core proceeding. Under section 157, a bankruptcy court may also “hear” a non-core proceeding or dispute that is merely related to a bankruptcy case, but cannot enter a final judgment; instead the bankruptcy court must submit proposed findings of fact and conclusions of law to the district court for a final determination of the dispute.
While section 157 gives bankruptcy courts statutory authority to enter a final judgment in a core proceeding, it does not provide bankruptcy courts with constitutional authority to rule on core proceedings and claims. In Stern v. Marshall, 564 U.S. 462, 499 (2011), the Supreme Court found that bankruptcy courts lack authority under the Constitution to enter a final judgment in a statutory core proceeding unless the claim or proceeding “stem[s] from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” Thus, notwithstanding its statutory authority granted by Congress, a bankruptcy court may enter a final judgment only in a core proceedings that arise under the Bankruptcy Code or that would not exist but for the bankruptcy case itself (such disputes are now commonly referred to as “constitutionally core claims”). Then in Exec. Benefits Ins. Agency v. Arkison, 573 U.S. 25 (2014), the Supreme Court held that when a bankruptcy court is faced with a claim that is statutorily core but constitutionally non-core (now referred to as a “Stern claim”), it must treat the claim as statutorily non-core and submit findings of fact and conclusions of law to the district court, which will make any final decision on the matter.
In CashCall, the Fourth Circuit found that, typically, arbitration of a constitutionally core claim will inherently conflict with key purposes of the Bankruptcy Code, including having bankruptcy judges determine disputes that arise from the Bankruptcy Code itself or that are otherwise integral to a debtor’s reorganization efforts. Thus, the court found that a bankruptcy court acts well within its discretion in retaining and ruling on a constitutionally core proceeding rather than enforcing an otherwise applicable arbitration agreement. On the other hand, a bankruptcy court’s discretion to deny enforcement of an arbitration provision is far more limited in a non-core proceeding.
CashCall presents an instructive application of the foregoing. In that case, a loan servicer asked the bankruptcy court to compel arbitration of two claims asserted by the debtor: a claim to declare a loan to the debtor illegal, and a separate claim for damages against the servicer for improper debt collection efforts relating to the loan. The Fourth Circuit denied arbitration as to the first claim because it would necessarily be resolved in the process of allowing or disallowing the servicer’s proof of claim based upon the loan. But the court required arbitration of the claim for damages for improper collection efforts because that proceeding was not dependent on whether the loan, and thus the servicer’s proof of claim, was valid – that claim would exist outside of bankruptcy and would not necessarily be determined in the claims allowance process.
So what conclusions can be drawn from this intellectual thicket? First, the core/non-core distinction is not mechanically dispositive as to whether a bankruptcy court may refuse to send a claim to arbitration. But while there are no hard-and-fast rules, there is a strong presumption, approaching a requirement, against enforcement of arbitration provisions in constitutionally core disputes, such as a dispute that would necessarily be resolved in the claims allowance process. On the other hand, there is a general presumption in favor of enforcement of arbitration provisions in non-core proceedings. There is simply less certainty regarding enforcement of arbitration agreements in mixed situations involving both constitutionally core claims and non-core or merely statutorily core claims – such matters will require a balancing of the applicable law and facts presented by the particular case.
Bottom line: not every question in life (or in law) has a clean, binary answer.
Hirschler’s Bankruptcy, Restructuring and Creditors Rights practice group regularly handles such matters before the Richmond court and the other bankruptcy courts throughout Virginia, Maryland and the District of Columbia. We would welcome the opportunity to apply our expertise to your bankruptcy needs.
Myrna H. Rooks