Denying Arbitration Of Legal Malpractice Case In Bankruptcy (Murray Energy Holdings)

By: Donald L Swanson

Bankruptcy Court denies a party’s request to enforce arbitration of a legal malpractice claim—and then dismisses that malpractice claim for failure to state a claim.

The opinion is Murray v. Willkie Farr & Gallagher LLP (In re Murray Energy Holdings Co.), Adv. Pro. No. 22-2007, Southern Ohio Bankruptcy Court (decided October 5, 2023, Doc. 89)—appeal is pending.

Context

The U.S. Supreme Court rarely allows a state or federal court to interfere with or impair arbitration agreement rights—in any context.

In bankruptcy contexts, however, the U.S. Supreme Court has thus far declined to grant a petition for writ of certiorari on arbitration.  The effect has been that the bankruptcy courts and their appellate overseers continue developing the contours and limits of arbitration rights in bankruptcy contexts.

The In re Murray Energy opinion is the latest example of how the contours and limits continue to be developed.  

Facts, Procedures & Arguments

After confirmation of a Chapter 11 Plan, Plaintiffs sue their attorneys in state court for legal malpractice during negotiations for Plan confirmation. 

Defendants remove the malpractice case to the Bankruptcy Court that handled the bankruptcy.

A month after filing the lawsuit, and before removal of the case to Bankruptcy Court, Plaintiffs also initiate an arbitration proceeding, asserting the same malpractice claim.

Both sides ask the Court to stay the adversary proceeding in favor of arbitration:

• Plaintiffs do so unreservedly; but
• Defendants do so only conditionally—i.e,, Defendants are ok with arbitration but only if the Bankruptcy Court does not dismiss the adversary proceeding for failure to state a claim.

Defendants argue that the confirmed Plan’s exculpation clause[fn. 1] bars Plaintiffs’ malpractice case.

Plaintiffs, in opposition, argue that the question of whether the Plan’s exculpation clause bars their malpractice case must be arbitrated. That’s because the engagement letter between Defendants and client provides:

• “In the event any dispute cannot be resolved informally, you agree to resolve any and all disputes . . . exclusively through private and confidential binding arbitration.”

First Question: Arbitration Agreement & Scope

The first arbitration question is whether the dispute falls within the scope of the arbitration provision of the agreement between the parties.

The answer to this first question is easy: the parties agree that they have a valid arbitration agreement and that the malpractice dispute falls within its scope.

Second Question: Core vs. Non-Core Proceeding

The second arbitration question is whether the malpractice claim qualifies as a core or a non-core proceeding.

The answer to this second question is two-fold:

• if it’s non-core, a bankruptcy court cannot preclude enforcement of the arbitration agreement—that’s the end of the inquiry; but
• if it’s core, a bankruptcy court moves to the next step in the analysis—i.e., whether enforcement of such an agreement would “inherently conflict” with the underlying purposes of the Bankruptcy Code.

“Inherent Conflict” Standard

The U.S. Supreme Court declares that the Federal Arbitration Act “establishes a federal policy favoring arbitration,” which policy requires courts to “rigorously enforce agreements to arbitrate.” 

Such policy, the Supreme Court adds, may be overridden only by “a contrary congressional command,” which contrary command may be deducible from these three sources:

1. statutory language;
2. legislative history; or
3. an “inherent conflict” between arbitration and the statute’s underlying purposes.

For arbitration enforcement issues in bankruptcy, the focus is on the third of these three sources—”inherent conflict”—because a contrary command does not appear in the Bankruptcy Code’s text nor in its legislative history.

Inherent conflicts between the Bankruptcy Code and the federal arbitration policy come from these sources:

1. the Bankruptcy Code’s purpose of centralizing resolution of purely bankruptcy issues in bankruptcy courts;
2. the need to protect creditors and reorganizing debtors from piecemeal litigation; and
3. “the undisputed power of a bankruptcy court to enforce its own orders.”

The third of these three sources—“to enforce its own orders”—exists because the Federal Arbitration Act does not divest courts of their authority to interpret their own orders.

And enforcing an exculpation clause in Debtor’s confirmed Chapter 11 Plan is tantamount to enforcing an order of the bankruptcy court. 

Exculpation Clauses

Exculpation clauses are a fundamental protection that the Bankruptcy Code permits Chapter 11 plans to afford.

Unlike releases (which provide for the relinquishment of claims), exculpation clauses establish the standard of care that will trigger liability in future litigation for acts arising out of a debtor’s bankruptcy.

The inclusion of an exculpation clause in a Chapter 11 plan is authorized by:

• § 1123(b)(6), which permits Chapter 11 plans to “include any . . . appropriate provision not inconsistent with the applicable provisions” of the Bankruptcy Code; and
• § 105(a), which empowers courts to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions” of the Bankruptcy Code.

Exculpation clauses are not only commonplace—but also play a central and vital role—in Chapter 11 plans.

In the present case, the Plan’s exculpation clause:

• is an essential Plan provision, because it protects those parties who participate in and contribute to Debtors’ chapter 11 process; and
• is appropriately tailored to protect the exculpated parties from inappropriate litigation.

Ruling

The Bankruptcy Court finds:

• arbitration disputes over the malpractice case present core claims that this Court is uniquely positioned to address under the authority granted by the Bankruptcy Code, Bankruptcy Rules, and related jurisdictional statutes;
• in this bankruptcy, an “inherent conflict” exists between the underlying purposes of the Bankruptcy Code and the enforcement of the arbitration agreement; and
• that’s because of the Bankruptcy Code’s purpose of permitting bankruptcy courts to enforce their own Chapter 11 plan confirmation orders.

Accordingly, the Bankruptcy Court:

• will not stay this adversary proceeding in favor of arbitration; and
• declares that the Bankruptcy Court is the proper forum for enforcement of the exculpation clause in the confirmed Chapter 11 Plan.

Conclusion

The In re Murray Energy opinion is another helpful addition to the body of case law on issues surrounding arbitration in bankruptcy.   

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Footnote 1. The confirmed Plan’s exculpation clause says: “each Exculpated Party is hereby exculpated from any Cause of Action for any claim related to any act or omission based on the negotiation, execution, and implementation of any transactions approved by the Bankruptcy Court in the Chapter 11 Cases . . . except for claims . . . [for] actual fraud, willful misconduct, or gross negligence,” and “Exculpated Party” includes “current . . . attorneys.”

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