Arbitration v. Bankruptcy—And Bankruptcy Prevails! (Harada v. Kapitus)

By: Donald L Swanson

There is an ongoing effort among bankruptcy courts and their appellate overseers to define the role and enforceability of contracts for arbitration in bankruptcy.

An example is from the Ninth Circuit Court of Appeals: Harada Family Dental Care, PC v. Kapitus Servicing, Inc, Case No. 25-6945 (9th Cir., decided May 21, 2026; Not for Publication).

In Harada v. Kapitus, the Ninth Circuit Court of Appeals addresses some interesting procedural issues and then rules on the merits of the arbitration dispute like this:

• the Bankruptcy Court did not abuse its discretion in denying arbitration;

The Arbitration “Merits”

The “merits” of the arbitration dispute involve Creditor’s merchant cash advance claim for $110,898.85 in Debtor’s Subchapter V bankruptcy. 

Debtor objects to Creditor’s claim on various grounds, including its violation of state usury laws.

The loan agreement between Creditor and Debtor contains an arbitration clause.  So, Creditor asks the Bankruptcy Court to compel arbitration of the claim disputes.  The Bankruptcy Court denies the motion, which denial (as noted above) is affirmed by the Ninth Circuit Court of Appeals. 

What follows is a summary of the Bankruptcy Court’s affirmed ruling and supporting rationale, which appear in Harada v. Strategic Funding, Adv. No. 25-04001 (Bankr. D. Mont., decided July 1, 2025, Doc. 23).

Core Proceeding

The allowance and disallowance of claims are core bankruptcy proceedings.  And that’s precisely what’s involved in this dispute.

Federal Policy on Arbitration

Creditor’s arguments rely heavily on the proposition that there is a liberal federal policy favoring contracts for arbitration.

Historically, contracts for arbitration enjoyed an exalted status as the “liberal policy favoring arbitration” became an automatic incantation for arbitration provisions and their enforceability. 

But the U.S. Supreme Court has clarified that the federal policy on arbitration is this:

• contracts for arbitration are as enforceable as other contracts, but not more so; and
• a court may not devise novel rules to favor arbitration over litigation.

Such Supreme Court clarification corrects the arbitration-is-favored error and demonstrates that arbitration agreements are neither special nor favored.

Impairment of Contracts—Including Arbitration Contracts

Contract rights are routinely impaired and adjusted in bankruptcy: prepetition contracts are scrutinized and restructured, and post-petition outcomes rarely mirror a creditor’s pre-petition contract.

Prepetition contracts for arbitration must fare the same, in bankruptcy, as other types of contracts—i.e., they may be enforced, adjusted or denied in the same manner as any other contract.

Centralization of Disputes

Centralization of disputes over a debtor’s legal obligations is a primary objective of the Bankruptcy Code.

If a creditor could avoid bankruptcy proceedings through a mechanical enforcement of contracts for arbitration, the centralization objective would be undermined. Similarly, this Court harbors doubts that an arbitrator should be afforded the opportunity to decide what is core and non-core in a bankruptcy context.

Bankruptcy courts are courts of limited jurisdiction established for the purpose of centralizing disputes. Contractual forum selection clauses in bankruptcy are analogous to contracts for arbitration: prepetition forum selection clauses in bankruptcy claim disputes are routinely ignored—and prepetition contracts for arbitration should receive the same treatment.

Bankruptcy Court’s Summary

Because these matters are core proceedings and arbitration would circumvent the objectives of the Bankruptcy Code, this Bankruptcy Court declines to enforce the contract for arbitration.

Ninth Circuit’s Explanation

In affirming the Bankruptcy Court’s ruling and rationale, the Ninth Circuit Court of Appeals provides the following explanation.

The Bankruptcy Court identified the “twin goals” of the Bankruptcy Code: distribution of assets and a fresh start for the debtor.

And it found that arbitration-induced delay would frustrate those goals because:

• Creditor’s claim would be the ultimate beneficiary, if Creditor prevails here, because distributions to Creditor under the Plan will increase; and
• the Small Business Administration risks having its distributions under the Plan modified and reduced.

Such findings are specific to this bankruptcy proceeding.

Nevertheless, Creditor argues that the Bankruptcy Court could not assume delay from arbitration absent a case-specific finding that arbitration itself would slow proceedings. However, this Court has ruled that arbitration of a creditor’s claim against a debtor, even if conducted expeditiously:

• prevents the coordinated resolution of debtor-creditor rights;
• can delay the confirmation of a plan of reorganization; and
• causes the Bankruptcy Court to lose control over the timing of the reorganization because it would not have control over the timing of the arbitrations.

Such reasoning is based on the structural features of arbitration, not specific findings as to how long a specific arbitration proceeding is likely to last.

So. the Bankruptcy Court was entitled to treat arbitration-induced delay as a relevant cost and to weigh it against the particularized creditor impacts it identified.

Conclusion

The Harada v. Kapitus opinions make sense.

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