Arbitration vs. Bankruptcy

Posted by NCBRC - September 20, 2012

Finding, under the circumstances of the case, that the Federal Arbitration Act conflicts with the underlying purposes of the Bankruptcy Code, the Ninth Circuit upheld the denial of the creditor’s motion to compel arbitration where such arbitration would necessarily have resolved a core bankruptcy issue. In re Eber, No. 11-55341 (9th Cir. July 9, 2012). The creditors sought arbitration to determine whether the debtor had committed fraud, breach of fiduciary duty, and willful injury, with respect to a contract for the construction and operation of a hair salon. The bankruptcy court denied the motion on the basis that findings on these issues would essentially decide the issue of whether the debts were nondischargeable under sections 523(a)(2), (4) and (6) of the Bankruptcy Code.

The court resolved the issue under the construct set forth in Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220, 226 (1987), which listed three considerations for determining whether the FAA conflicts with another federal law: “(1) the text of the statute; (2) its legislative history; and (3) whether an inherent conflict between arbitration and the underlying purposes of the statute exists.”

The Eber court found that there was no textual or historical basis for carving out a broad exception to the FAA in the bankruptcy context and, in fact, noted that a bankruptcy court generally does not have discretion to deny arbitration in non-core matters. In core matters, however, the McMahon construct applies. Under that framework, the court considered whether there was an inherent conflict between the FAA and the Bankruptcy Code when it came to dischargeability under sections 523(a)(2), (4) and (6). Weighing the objectives of the Code including centralization of disputes and avoidance of piecemeal litigation, against the favored method of dispute resolution provided by arbitration, the court found that the lower court had not abused its discretion when it found a decision as to whether the debtor had committed fraud was so closely intertwined with the issue of dischargeability that arbitration would conflict with the “underlying purposes of the Bankruptcy Code” and jeopardize a core bankruptcy proceeding.

The Eber court was also guided by its decision earlier this year in the chapter 11 case of In re Thorpe Insulation Co., 671 F.3d 1011 (9th Cir.), petition for cert. filed, Continental Insurance Co. v. Thorpe Insulation Co., No. 1310 (U.S. Apr. 30, 2012). Though the petitioner in Thorpe argues in its petition that a conflict among circuits has arisen under which certain courts have allowed the concept of centralization of bankruptcy claims to outweigh the dispute resolution benefits of arbitration as a matter of law, in fact, courts generally, and correctly, weigh the two considerations among others in performing the McMahon analysis. See, e.g. In re Electric Machinery Enterprises, Inc., 479 F.3d 791 (11th Cir. 2007); In re Mintze, 434 F.3d 222 (3d Cir. 2005); In re White Mountain Mining Co., 403 F.3d 164 (4th Cir. 2005); In re Gandy, 299 F.3d 489 (5th Cir. 2002).

Eber opinion


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