Court Declines to Enforce Arbitration Clause in Student Loan Agreement

Posted by NCBRC - December 13, 2018

An arbitration clause in a student loan contract is unenforceable where the debtor seeks an order of discharge of the loan in bankruptcy. Roth v. Butler University (In re Roth), No. 17-4109, Adv. Proc. No. 18-50097 (Bankr. S.D. Ind. Nov. 16, 2018).

After Matthew Roth obtained his chapter 7 discharge, he moved to reopen his bankruptcy to seek discharge of his student loans under section 523(a)(8). One of his student loan lenders, Sallie Mae, answered with a motion to compel arbitration based on the terms of the student loan agreement.

In arguing that the preference for arbitration under the Federal Arbitration Act requires enforcement of the arbitration clause, Sallie Mae relied on Epic Sys. Corp. v. Lewis, — U.S. –, 138 S.Ct. 1612, 1622 (2018). There, the Court found that for a conflicting federal law to override the Federal Arbitration Act, Congress’s intent must be manifest in the language of the overriding law. In this case, there was no dispute that section 523(a)(8) does not explicitly override the FAA.

The court noted, however, that in Shearson/American Exp., Inc. v. McMahon, 482 U.S. 220 (1987), the Supreme Court declined to rely solely on explicit statutory text of preclusion. Instead, the Court held that a federal law may override the FAA if such override is justified by “(1) the statute’s text; (2) the statute’s legislative history; or (3) an inherent conflict between arbitration and the statute’s underlying purpose.” In the absence of clear direction in the statutory text or legislative history, the bankruptcy court here turned to the third alternative: that of inherent conflict. Where an arbitration clause is merely a contractual agreement like any other, and the Bankruptcy Code frequently permits modification of contractual rights, the court found it reasonable to conclude that an arbitration clause may, as a general proposition, succumb to conflicting bankruptcy laws. Courts declining to enforce arbitration clauses in bankruptcy have relied on the fact that the issue involved was a core bankruptcy question. Here, the issues—whether the challenged loan was a “qualified educational loan” and whether it was dischargeable—met that standard.

Sallie Mae argued that there was no inherent conflict between the arbitration clause and the Code because Mr. Roth had already received his discharge, the case was closed, and there were no assets left to distribute to creditors.

The court disagreed. Where a fundamental purpose of bankruptcy is to afford the debtor a fresh start and where that fresh start is dependent upon the enforceability of discharge, permitting an arbitrator to make a determination of dischargeability would interfere with a basic function of the bankruptcy court. In fact, the court found that permitting an arbitrator to determine dischargeability “would effectively allow parties to contractually overrule the application of federal bankruptcy law.”

The court noted that Mr. Roth had claims against other student loan creditors as well, and a finding that would allow Sallie Mae to arbitrate its claim, would require Mr. Roth to argue that same issues in two fora, in conflict with the principle of centralizing litigation. The court denied Sallie Mae’s motion to compel arbitration.

Roth Bankr SD Ind Nov 2018

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