Federal Arbitration Act Needs a Bankruptcy Exception

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A Forum (photo by Marilyn Swanson)

By Donald L. Swanson

This article is in follow-up to a prior one titled, “Federal Arbitration Act vs. Stern v. Marshall: So . . . What’s Fair About This?”  The point here is that we need a bankruptcy exception to the Federal Arbitration Act.

Litigation in bankruptcy:

Here’s how the issue arises.

A Chapter 7, 11, 12 or 13 case is on file in bankruptcy court. Someone files a motion, objection or adversary proceeding. Lo and behold, one of the parties demands that the newly-filed dispute proceed in arbitration because of, (i) language in a pre-petition contract between the parties, and (ii) Federal Arbitration Act provisions. Such Act makes no mention of a bankruptcy exception, so arbitration is required for the bankruptcy dispute, some courts say, even in core matters.

Such a result is an inequity–no, it’s a travesty–in the vast majority of bankruptcy cases. The reason is this: excess costs of arbitration. I’ll try to explain.

A Contrast in Costs:

A lawsuit is initiated with payment of a filing fee to the court. Such fees are commonly in modest amounts (e.g., from <$100 to a few hundred), due to economies of scale (lots of lawsuits are filed) and taxpayer subsidies. But that’s, typically, the only payment parties make to the court for its clerical and judicial services. Salaries and pensions of judges, law clerks, clerks of court, court reporters and supporting personnel, for example, are all paid, in their entirety, from tax dollars.

In an arbitration, a filing fee is also required. But economies of scale don’t exist, and there is no tax subsidy. Additionally, fees of arbitrators, arbitration administrators, arbitration reporters and supporting personnel must be paid, in their entirety, by the litigating parties. There is no tax subsidy.  Such fees can be substantial.

So . . . it’s easy to see how arbitration costs are materially higher at the outset than in a lawsuit. And that’s before fees of attorneys, process servers, deposition reporters and expert witnesses are added on.

News Flash:

–Consumer and small business bankruptcy cases cannot afford the added costs of arbitration.  So arbitration provides a huge litigation advantage to deep pocket creditors over cash-strapped debtors — an advantage that’s unrelated to the merits of the dispute.

–The vast majority of all bankruptcy cases are, (i) consumer cases under Chapters 7 and 13, and (ii) small business cases under Chapters 11 and 12.

Accordingly, requiring arbitration in consumer and small business cases would be an injustice and a travesty.

Forum Shopping:

So . . . it’s not surprising that a deep-pocket litigant would want to demand arbitration, when litigating with a consumer or small business debtor in bankruptcy.

It’s a standard forum shopping strategy: seeking the most-advantageous litigation forum.

However, forum shopping strategies of all types are disfavored everywhere–especially when an injustice results.

The possibility of arbitration forum shopping in consumer and small business bankruptcies needs to stop!

Conclusion:

If the courts can’t or won’t find a way to stop it, then Congress needs to solve this forum shopping problem!

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