Bankruptcy Code Meets Federal Arbitration Act — At U.S. Supreme Court? (GE v. Belton)

Uniformity (photo by Marilyn Swanson)

By: Donald L Swanson

Uh-oh! 

The U.S. Supreme Court is requiring action on a certiorari petition that presents a Bankruptcy Code meets Federal Arbitration Act (“FAA”) question.

Here is what’s happened:

  • November 10, 2014:  SDNY Bankruptcy Judge, Hon. Robert D. Drain, refuses to allow arbitration of a Debtor’s request to hold Creditor in contempt for violating the discharge injunction.  
  • October 14, 2015:  On appeal, the SDNY District Judge reverses and remands “with instructions to grant the respective motions to compel and stay . . . pending arbitration.”
  • March 4, 2019:  On motions for reconsideration, the same District Judge vacates his prior order and affirms the Bankruptcy Judge’s arbitration refusal, based on the intervening opinion of In re Anderson, 884 F.3d 382 (2d Cir. 2018).
  • June 16, 2020:  Second Circuit affirms Bankruptcy Judge’s decision because the Bankruptcy Code and FAA are in “inherent conflict” on this dispute and because “that is enough to displace the Arbitration Act.”
  • October 9, 2020:  Petition for a writ of certiorari is filed in U.S. Supreme Court (Case No. 19-481) and captioned, GE Capital Retail Bank, Petitioner v. Nyree Belton.
  • November 24, 2020:  Respondent files a Waiver of right to respond.
  • January 4, 2021:  U.S. Supreme Court makes this entry: “Response Requested. (Due February 3, 2021)” (emphasis added).

Uniformity Discussion

For a recent discussion of the Bankruptcy Code meets FAA issue and a uniformity argument under the U.S. Constitution, based on an 1843 opinion by U.S. Supreme Court Justice John Catron, see Bankruptcy’s Uniformity Requirement & Federal Arbitration Act (Nelson v. Carland).

Bankruptcy Judge’s Ruling

The SDNY Bankruptcy Judge’s ruling is interesting and instructive and reveals some passion.  What follows is an attempt at summarizing the Bankruptcy Judge’s ruling.

–Facts

Debtor files a Complaint in Bankruptcy Court seeking to enforce the discharge of her debt against Creditor.

The Complaint alleges that Creditor, while aware of Debtor’s discharge, (i) failed to correct one or more credit reports to show that her debt to Creditor was discharged in bankruptcy, and (ii) did so in an effort to enforce the discharged debt. 

Creditor files a motion to stay the adversary proceeding and compel arbitration of the dispute under terms of, (i) the FAA, and (ii) the contract between Debtor and Creditor, which provides, “Any legal dispute or claim of any kind . . . that relate in any way to your account, card, or your relationship with us will be resolved by binding arbitration.”

–General Steps for Analysis

Here are the general steps for deciding the motion to compel arbitration in this case, under the FAA:

  1. Determine whether the parties in fact agreed to arbitrate the dispute at issue; 
  2. Determine the scope of the parties’ agreement to arbitrate and whether the agreement is revocable, “with a healthy regard for the federal policy favoring arbitration [such that] any doubts . . . should be resolved in favor of arbitration”;
  3. Consider whether Congress intended the dispute to be non-arbitrable, with the burden on the party opposing arbitration to establish such contrary congressional intent; and
  4. Refuse to enforce an arbitration agreement that prevents the “effective vindication of a statutory right.”

The parties disagree on both (i) the scope of the arbitration provision in their contract — i.e., whether they could have intended it to cover a claim to enforce Debtor’s bankruptcy discharge, and (ii) whether Congress intended such a claim to be non-arbitrable.

–Inherent Conflicts

It has long been recognized that bankruptcy proceedings raise inherent conflicts with the policies and purposes of the FAA.  Examples include:

  • Bankruptcy cases are predominantly collective, multi-party proceedings (including the U.S. Trustee) rather than two-party disputes, with the debtor often a mere stakeholder, so that prepetition agreements between a debtor and creditor to arbitrate do not cover disputes in a bankruptcy that involve multiple new parties; and
  • The Bankruptcy Code abrogates individual contract rights so that claims against a debtor and debtor’s assets can be determined in one forum under the supervision of one judge—and courts have long held that disputes essential to the bankruptcy process should not be subject to arbitration. 

–Congressional Intent

Then there’s this question: Did Congress implicitly exclude bankruptcy disputes from FAA’s arbitration requirements, since policy conflicts of “near polar extremes” often arise between the FAA and the Bankruptcy Code?

Here’s how the Bankruptcy Judge analyzes this question, under Second Circuit criteria.

First, as to “non-core” and “related to” bankruptcy disputes, the presumption in favor of arbitration usually trumps the lesser interest of bankruptcy courts. 

“Core” bankruptcy matters, on the other hand, implicate more pressing bankruptcy concerns, especially as to disputes, (i) based on “provisions of the Bankruptcy Code that inherently conflict with” the FAA, or (ii) where arbitration would jeopardize Bankruptcy Code objectives, such as centralized resolution of purely bankruptcy issues, protecting creditors and reorganizing debtors from piecemeal litigation, and enforcing a bankruptcy court’s own orders.

Creditor contends that, since the present case is not a multi-party dispute, the Bankruptcy Code’s centralization policy does not apply. The Bankruptcy Judge rejects this contention as dispositive because the discharge dispute at issue “is fundamental to the adjustment of the debtor/creditor relationship” and because arbitration would “seriously impinge on” the bankruptcy court function. That’s because “there is nothing more fundamental to bankruptcy relief than the discharge and its related fresh start.”  

Here’s the explanation: 

  • “This Court sees hundreds of individual debtors in bankruptcy every month . . . seeking to save their house or other valuable property . . . [T]he vast majority of debtors view bankruptcy as a last resort and seriously regret having to invoke it”; 
  • “When they file for bankruptcy relief, they subject themselves, moreover, to scrutiny of their financial condition at the most minute level. . . . so that any creditor, in addition to being able to take essentially unfettered discovery of the debtor’s financial condition, . . . can also . . . pursue the denial of his or her discharge”;
  • “Why then do debtors seek this relief”?  Because they need the discharge — “The discharge is why they subject themselves to everything else”; and
  • If a party subsequently violates the discharge, the debtor’s reason for seeking relief and enduring all of the constraints imposed by Congress in the Bankruptcy Code go for nothing . . . the effectiveness of bankruptcy as a fair, collective remedy for creditors and a fresh start for debtors is eviscerated.

–Other Concerns

Other, lesser concerns also support Debtor’s objection to arbitration.

Efficient resolution of claims and conservation of estate assets are integral purposes of the Bankruptcy Code. Such purposes can present a conflict between the FAA and the Bankruptcy Code — e.g., where arbitration costs or delays would prejudice the rights of creditors or the ability of a debtor to reorganize.

Such purposes and conflicts exist here:

  1. The present agreement provides for Creditor to pay arbitrator fees up to $2,500—with Debtor obligated for additional fees; in Bankruptcy Court, by contrast, the Judge’s services are provided at no charge to the parties.   “Is it not logical” to assume that Congress meant for a debtor (who recently emerged from bankruptcy with non-exempt assets liquidated and with access to a bankruptcy court at no charge) to run the risk of incurring arbitration costs; and
  2. Timely and effective enforcement of the discharge is also critical for a debtor’s fresh start—it’s the difference between resuming normal economic life and destitution.

As to timely enforcement, the Complaint alleges that Debtor took prompt action upon learning that her credit report still reflected her debt as outstanding.  No debtor should have to wait any longer than is necessary to ensure that the discharge is enforced: e.g., every day that a credit report is inaccurate is another day that debtor believes she must pay her debt or be turned down for new credit. This raises two concerns: arbitration panels have limited ability to,

  • grant timely relief—e.g., delays are inherent in the arbitration process; and
  • grant effective relief—e.g., arbitrators are unable to issue effective injunctions.

Therefore, “Congress intended the prompt and well established enforcement of the discharge to be left to a single bankruptcy judge who issued it” and who handles such matters routinely.

Contract—And Passion

The Bankruptcy Judge sees inconsistent logic in the related roles and powers of arbitrators and bankruptcy judges—and shows passion on the issue. 

The inconsistency is this: how can arbitrators resolve disputes by contract of the parties, when bankruptcy judges can’t.

Here’s the gist of the Bankruptcy Judge’s passion (emphasis is added).

  • The Supreme Court observes, “The FAA reflects the overarching principle that arbitration is a matter of contract.” 
  • In the FAA, Congress requires adjudication of a dispute by arbitrators, (i) who do not have life tenure, (ii) whose salaries are not protected by the Constitution, (iii) who do not even have to be lawyers, let alone judges, and (iv) whose decisions are subject only to a rubber-stamp review by federal courts (reversal can occur only for the arbitrator’s corruption, fraud, undue means, or other misconduct).
  • By contrast, parties cannot contract to adjudication of the same disputes by bankruptcy judges, (i) who are experts in the bankruptcy realm, and (ii) whose decisions are subject to full appellate review. 
  • This contrast exists solely because bankruptcy judges don’t have lifetime tenure and salary protection under Article III of the Constitution. 

Under such circumstances, it “boggles the mind” that federal courts must do the bidding of such arbitrators.

Faulty logic is at the bottom of all this and needs to be overturned, since “nothing is more fundamental to the adjustment of debtor/creditor relations than the enforcement of a debtor’s discharge.”

Conclusion

Here’s a “thank you” to the SDNY Bankruptcy Judge for this Bankruptcy Code meets FAA opinion and for the passion behind it.

Here’s hoping that the reasoning and result of his opinion prevail!

** 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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