Arbitration of Bankruptcy Disputes: The Need for a “Uniformity” Rationale Under U.S. Constitution

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Bankruptcy and the U.S. Constitution (photo by Marilyn Swanson)

By:  Donald L. Swanson

The case is Thomas v Midland Funding LLC, A.P. No. 17-05010 in the Bankruptcy Court for the Western District of Virginia. On appeal, it’s Civil Action No. 5:18-cv-00128 in the U.S. District Court.

Odd Facts

The facts of the case are a kind of, “Who knew this happens?”

Debtor is in Chapter 13 bankruptcy.  A credit card lender, upon learning of Debtor’s bankruptcy filing, assigns its claim against Debtor to Midland Funding LLC, who files a proof of claim in Debtor’s bankruptcy. Buying such claims is a regular part of Midland Funding’s business.

–Alleged Rule 3001(c) Violation

On the proof of claim it files, Midland Funding:

  • answers, “No,” to the question, “Does this amount include interest or other charges?” and
  • also asserts that the claim amount includes zero dollars of interest and fees; but
  • in truth, the claim amount includes both interest and fees.

–Debtor’s Lawsuit

So, Debtor sues Midland Funding, claiming a violation of Fed.R.Bankr.P. 3001(c).  Such Rule, (i) requires a disclosure of interest and fees in a proof of claim, and (ii) provides sanctions for failing to do so, including an award of attorney fees.

Debtor’s lawsuit also includes a damages claim for violation of the Fair Debt Collection Practices Act (15 USC § 1692, et seq.), which damages claim is also based on the same Rule 3001(c) violations.

Arbitration Demand and Result

The credit card agreement Debtor signed contains a requirement that disputes over that debt be sent to arbitration. So, Midland Funding asks the Bankruptcy Court to enforce the arbitration provision and dismiss Debtor’s lawsuit.

The Bankruptcy Court declines to enforce the arbitration provision (see Memorandum Opinion dated September 28, 2018—Doc. 45). Here is its reasoning:

  • It would be “nonsensical” for a bankruptcy court to “submit to an arbitrator” questions like, (i) “whether an alleged violation of Rule 3001 occurred,” and (ii) if so, “whether any relief is appropriate”;
  • That’s because Rule 3001 is “a procedural apparatus” that’s only “applicable” in a bankruptcy court.

On appeal, the District Court agrees, in an Memorandum Opinion dated August 13, 2019 (Doc. 26).  Here is its reasoning:

  • “Allowing the arbitrator to enforce the requirements” of Rule 3001 would “conflict with the purposes of the Bankruptcy Code”; and
  • “giving an arbitrator supervisory authority over the claim-filing process would substantially interfere” with a bankruptcy debtor’s “efforts to reorganize” in bankruptcy.

Kudos to these two courts for this result [not that either cares about kudos from the likes of me].

An Additional Argument is Needed

The problem with the rationale asserted by the Bankruptcy and District courts in the case is this:

  • While the U.S. Supreme Court acknowledges that exceptions can exist to enforcing mandatory arbitration provisions, the Supreme Court justices have yet to find an exception they can recognize; and
  • Bankruptcy courts need a stronger rationale that applies to a broader range of disputes before them.

The “Rubber-Stamp” Standard of Review: A Problem & A Solution

Here is a fundamental problem for bankruptcy courts:

  • The “Bankruptcies” provision of the U.S. Constitution requires a “uniform” application of bankruptcy laws throughout the U.S. bankruptcy system;
  • “Rubber-stamp” is the standard of review for arbitration rulings; and
  • A rubber-stamp standard eliminates all possibilities of assuring a “uniform” application of bankruptcy laws throughout the U.S. bankruptcy system.

Accordingly, the U.S. Constitution requires a scale-back of arbitration enforcement in bankruptcy disputes.  See this linked article.

Conclusion

Here’s wishing and hoping that bankruptcy courts and their appellate overseers will incorporate a uniformity rationale, from the U.S. Constitution, into rulings on arbitration clauses for bankruptcy disputes.  Such a rationale would provide a strong and unique basis (from the U.S. Constitution, no less) for excluding core bankruptcy disputes from arbitration requirements.

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

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