When Claim Objection Must Go To Arbitration—And When Not: Defensive v. Offensive Deployment (Johnson v. S.A.I.L.)

Offensive or defensive deployment? (Photo by Marilyn Swanson)

By: Donald L Swanson

It’s a defense v. offense distinction:

  • Defense—An objection and counterclaim designed to diminish or zero-out a proof of claim in bankruptcy is not subject to arbitration; but
  • Offense—An objection or counterclaim designed to do anything more . . . can be compelled to arbitrate.

That’s the essence of a recent opinion in Johnson v. S.A.I.L. LLC (In re Johnson), Adv. No. 22 -172, Northern Illinois Bankruptcy Court (issued March 28, 2023; Doc. 18).  What follows is a summary of that opinion.


S.A.I.L. is a high interest lender to consumers.   

In spring of 2022, Johnson needs $4,000, finds S.A.I.L. on the Internet, and reads the material on S.A.I.L.’s website.

Then, Johnson borrows $4,000 from S.A.I.L.  The proceeds are distributed like this:

  • $1,000 – directly to Johnson;
  • $3,000 – deposited on Johnson’s behalf with S.A.I.L.’s bank.

Loan documents provide that “all Disputes shall be resolved by binding arbitration pursuant to and under the Federal Arbitration Act.”

Debtor files Chapter 13 and proposes a plan. 

S.A.I.L. files a proof of claim for $3,741.28, secured in the amount of $3,000 by a “Collateral Deposit.”


Johnson sues S.A.I.L., in her bankruptcy, asserting three counts (also called objections to and counterclaims against S.A.I.L.’s proof of claim):

  1. Count I: that S.A.I.L.’s Claim be denied and that S.A.I.L.’s loan to her be voided under Illinois laws because the $3,000 deposited on her behalf with S.A.I.L.’s bank is a “device, subterfuge, or pretense to evade the requirements” of Illinois predatory loan and consumer fraud laws. 
  2. Count II: for relief under Illinois interest laws because S.A.I.L. charged her unlawful interest.
  3. Count II: for relief under Illinois consumer fraud laws because of S.A.I.L.’s deceptive and misleading representations about its loans to induce her to take the loan.

Motion to Compel

In response, S.A.I.L. files a Motion to Compel—asking the Bankruptcy Court to (i) enforce the arbitration provision of the contract between the parties, and (ii) require that Johnson’s claims be resolved by arbitration.

S.A.I.L. argues the arbitration agreement must be rigorously enforced because:

  • the Supreme Court has instructed lower courts to implement arbitration agreements in cases where the dispute falls within the arbitration clause;
  • Debtor’s claims are under state laws and are not core claims in bankruptcy;
  • even if Johnson’s claims are core, the court must have a compelling reason to deviate from Congress’s strong preference that the arbitration agreement be enforced; and
  • Johnson has not shown an inherent conflict between the Federal Arbitration Act and the purpose of the Bankruptcy Code.

Arbitration Law

Congress enacted the Federal Arbitration Act (“FAA”) in 1925, in response to widespread judicial hostility to arbitration agreements—English and American courts had routinely refused to enforce arbitration agreements.

The primary FAA provision says: “A written provision in any . . . contract . . . to settle by arbitration a controversy . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract or as otherwise provided in chapter 4.”

The U.S. Supreme Court has interpreted such provision as containing “two clauses:

  1. an enforcement mandate, rendering agreements to arbitrate enforceable as a matter of federal law; and
  2. a saving clause, permitting invalidation of arbitration clauses on grounds applicable to any contract.”

The FAA is a congressional declaration favoring enforcement of arbitration agreements: but the federal policy is about treating arbitration contracts like all others, not about fostering arbitration.

The Parties’ Agreement

Under their loan documents, the parties have agreed to arbitrate Johnson’s three-count suit. 

So, the question is whether that agreement should be enforced.

Enforcement Standards

The courts must “rigorously” enforce the agreement to arbitrate.

But such requirement can be overridden by a contrary congressional command that is deducible from:

  • a statute’s text;
  • legislative history; or
  • an inherent conflict between arbitration and the contrary statute’s underlying purposes.

When two acts of Congress touch on the same topic, the Courts must strive to give effect to both.

The party opposing arbitration has a strong burden to overcome.

Neither the U.S. Supreme Court nor any Circuit Court of Appeals has found that the Bankruptcy Code’s text or legislative history clearly express an intent to except claims from arbitration.

So, the key is whether an inherent conflict exists between arbitration and the underlying purposes of the Bankruptcy Code on the dispute for which an arbitration exception is requested.

Whether the dispute is core or non-core is not a determinative distinction—that’s because the distinction is only relevant on whether a bankruptcy court may enter a final judgment in a dispute on its own authority.

But the core v. non-core distinction may be considered in the inherent conflict analysis. 

Does an inherent conflict exist?

Does an inherent conflict exist between the FAA and the Bankruptcy Code regarding the three counts identified in Johnson’s suit?

Congress granted comprehensive jurisdiction to bankruptcy courts to deal efficiently and expeditiously with all matters connected with the bankruptcy estate.

One primary bankruptcy purpose is to secure a prompt and effectual administration and settlement of the estate.  To effectuate that purpose, the Bankruptcy Code:

  • gives bankruptcy courts in rem jurisdiction over property of the estate;
  • centralizes disputes over debtor’s assets and obligations into one forum (the bankruptcy court) to protect both debtors and creditors from piecemeal litigation and conflicting judgments; and
  • brings all interested parties to that one court with its expansive in rem jurisdiction and efficient processes.

The Bankruptcy Code provides for an explicit claims filing and management process.

Objections to the allowance of claims must be grounded in one of the nine exceptions described in 11 U.S.C. § 502(b).

Under those grounds, claim objections on state law grounds are statutorily core.

The Supreme Court has distinguished, however, between statutorily core claims and constitutionally core claims.  See Stern v. Marshall, 564 U.S. 462, 482 (2011). 

Constitutionally core disputes: 

  • stem from the bankruptcy itself; or
  • would necessarily be resolved in the claims allowance process.

Here’s a constitutionally core distinction on claims allowance issues:

  • a debtor seeking to reduce the amount a debtor owes to a claimant is constitutionally core; whereas
  • a debtor seeking affirmative monetary relief from a claimant to augment the bankruptcy estate is not constitutionally core.

Do the FAA and Bankruptcy Code inherently conflict?

In a constitutionally-core claim objection, like the one in this case, arbitration is inconsistent with centralized decision-making because:

  • arbitration makes debtor-creditor rights contingent upon an arbitrator’s ruling rather than the bankruptcy judge’s ruling; and
  • arbitration puts the plan process on hold pending resolution of the arbitration (and in the present case, it’s a 100% payment plan).

That is an inherent conflict.

Other factors

The Bankruptcy Code enables bankruptcy courts to deal with the interests and of multiple parties—each of whom has a right to appear and be heard on any issue—effectively and expeditiously.

  • Arbitration, by contrast, is specific to the named parties and excludes the interests and arguments of everyone else.

Circuit Courts of Appeal have affirmed a bankruptcy court’s rejection of an arbitration request when doing so would conflict with the purposes of the Bankruptcy Code.[Fn. 1}

Trial-level courts have also refused to enforce arbitration agreements when doing so would conflict with the purposes of the Bankruptcy Code.[Fn.2]

Debtor’s case is essentially on hold while awaiting a resolution of S.A.I.L.’s Motion to Compel.

Debtor cannot move forward on confirmation, and creditors cannot receive payment on their claims—all because S.A.I.L. wants to arbitrate its claim.

Cases cited by S.A.I.L. don’t actually support its position.  For example, in Argon Credit, the court found “that the arbitrations at issue are neither actions by nor against the Debtor; rather, they are actions by third-parties against third-parties.”

Accordingly, Johnson’s counts I and III will not be sent to arbitration, and the Motion to Compel will be denied as to those counts.

Count II

Claims in Count II of Johnson’s suit do not involve an inherent conflict between the FAA and the Bankruptcy Code.  That’s because the Count seeks to do more than diminish or zero-out S.A.I.L.’s claim.

Consequently, the Motion to Compel will be granted as to Count II. 

Meanwhile, Debtor’s plan can provide for what happens when the arbitration result on Count II becomes known—and the plan can be amended at that time, if need be.   


According to Johnson v. S.A.I.L.:

  • Using a claim objection or counterclaim in a defensive deployment is not subject to an arbitration clause in the agreement between debtor and the creditor; but
  • Using it for more than that (as an offensive deployment), reaches an opposite result.


Footnote 1.  Multiple citations to and descriptions of such circuit court opinions appear at 21-22 of the opinion.

Footnote 2.  Multiple citations to and descriptions of such trial-level opinions appear at 22-23 of the opinion.

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