Arbitration Clause Not Enforced in Discharge Violation Case

Posted by NCBRC - June 24, 2020

In the absence of intervening legislative or Supreme Court directive, the Second Circuit followed its precedent finding that a debtor could not be compelled to arbitrate his contempt motion for violation of the discharge injunction. Belton v. GE Capital Retail Bank, No. 19-648 (2d Cir. June 16, 2020) (consolidated with Bruce v. Citicorp Inc., No. 19-655).

After the debtors received bankruptcy discharges, they filed claims against their credit card companies for violation of the discharge injunction. In both cases, the credit card agreement included a mandatory arbitration clause which the companies sought to enforce.

In its discussion on appeal, the circuit court turned to its earlier finding in the nearly identical case of Anderson v. Credit One Bank, N.A. (In re Anderson), 884 F.3d 382 (2d Cir.), cert. denied, 139 S. Ct. 144 (2018). The Anderson court found that there was an “inherent conflict” between the Federal Arbitration Act and the Bankruptcy Code. The Anderson court then applied the test set forth in Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 226 (1987), for addressing conflicts between the FAA and other federal statutes. It found that: “(1) the discharge injunction is ‘integral’ to the bankruptcy process; (2) ‘the claim [concerns] an ongoing bankruptcy matter that requires continuing court supervision;’ and (3) ‘the equitable powers of the bankruptcy court to enforce its own injunctions are central to the structure of the Code.’” Id. at 390. Relying on these findings, the Anderson court held that the Code displaced the FAA and denied the creditor’s motion to compel. The Belton court noted, however, that the Anderson court reached its decision “without considering the Code’s text or legislative history, which the parties had not argued before the district court.”

The creditors argued that the Supreme Court’s more recent decision in Epic Systems Corp. v. Lewis, 138 S. Ct. 1612 (2018), undermined the finding in McMahon that an inherent conflict may be sufficient to supplant the FAA. The Belton court disagreed, finding that, while Epic stressed the heavy burden carried by the party seeking to displace the FAA, the test the Court ultimately employed was essentially the same as that used in McMahon. To the extent Epic altered McMahon, the court stated: “we see Epic Systems as clarifying that where two of McMahon’s factors clash, a court should resolve the dispute in favor of the statutory text and any contextual clues derived therefrom.”

In the face of the Code’s silence as to its interaction with the FAA, the creditors argued that Congress intended that the Act not be displaced. In support of that position, they argued that where the Bankruptcy Code permits state courts to address the impact of the discharge injunction in a post-discharge collection case, arbitrators are likewise competent to rectify a discharge injunction violation.

The court disagreed. It distinguished the scenario of a debtor using the discharge injunction as a defense in the state court from a contempt action for violation of the discharge injunction. Where debtors do not have a private right of action for violation of the discharge injunction, their only recourse for the violation is through a contempt proceeding, and courts have found that those cases must be brought in the court that entered the order at issue. The Second Circuit found therefore, that neither the text of the Code, nor the legislative history offered an answer to the conflict between the two statutes. Finding its hands tied by the decision in Anderson, the court affirmed.

The court cautioned “we have not endeavored to address whether a nationwide class action is a permissible vehicle for adjudicating thousands of contempt proceedings, and neither our decision today nor Anderson should be read as a tacit endorsement of such.”

Belton 2d Cir June 2020

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