The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:
In Belton v. GE Capital Retail Bank (In re Belton), ___ F.3d ___, 2020 WL 3240593 (2nd Cir. 2020), the United States Second Circuit Court of Appeals (the “Second Circuit” or the “court”), held that a creditor cannot enforce an arbitration clause in a credit card agreement in a contempt proceeding the debtor brought against the creditor for violation of the discharge injunction.
The opinion in Belton can be found here.
The Beltons opened credit card accounts with two banks. The card agreements contained clauses mandating arbitration of any dispute. The Beltons quickly fell behind. Eventually the appellant banks charged off the accounts, converting their accounting of the obligations from receivables to losses, and sold the debts to a third party. The banks reported these developments to credit agencies, which reported the debts as charged off, indicating that the debts were delinquent but still existed. Later, the Beltons filed successive separate Chapter 7 cases. Each received a discharge in due course. Under Bankruptcy Code (the “Code”) section 524(a)(2) the bankruptcy court discharge orders enjoined creditors, including the appellants, from collecting discharged debts from the Beltons. However, the banks did not report the discharges to the credit agencies, which therefore continued to report the debts as charged off, meaning delinquent but still extant.
Claiming that the banks’ failure to advise the credit agencies that their debts had been discharged was a deliberate strategy to coerce them into paying the debts, the Beltons reopened their cases and brought adversary proceedings against the banks for contempt in violating the discharge injunction. The banks moved to enforce the arbitration clauses of the credit card agreements, citing the prescription of the Federal Arbitration Act (the “FAA”). The FAA requires federal courts to enforce arbitration agreements. However, the bankruptcy court denied the motions. Upon the banks’ appeals, the district court affirmed. The courts at both levels found that because of an “inherent conflict” with the Code, the FAA was subordinate to the Code as the enforcement mechanism. The banks appealed to the Second Circuit, which affirmed.
The decision revolved around two cases. The first is Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 226 (1987). There the Supreme Court formulated the test for resolving statutory conflicts. A mandatory statutory prescription can be overcome by “contrary congressional intent.” Evidence of that intent can include the text of the statute itself, legislative history or “an inherent conflict between arbitration and the statute’s underlying purposes.” Id. at 227. The other case is the Second Circuit’s own decision in Anderson v Credit Bank, N.A. (In re Anderson), 884 F3d 382 (2nd Cir.), cert. denied, ___ U.S. ___, 139 S. Ct. 144 (2018). In that case, the Second Circuit found that statutory power of a bankruptcy court to resolve and punish an alleged violation of the discharge injunction overrides the FAA.
Finding that Anderson is virtually identical to Belton, the court felt bound by Anderson. But it did not stop at invoking its prior precedent in Anderson. That is because the banks argued that the intervening Supreme Court case of was Epic Systems Corp. v. Lewis, ___ U.S. ___, 138 S. Ct. 1612, 200 L.Ed.2d 889 (2018) undermined McMahon by holding that an “inherent conflict” between another statute and the FAA—the third of the three McMahon tests—by itself is never enough to override the FAA. However, the court disagreed with the banks’ interpretation of Epic. It found that although Epic describes “an exacting gauntlet through which a party must run to demonstrate congressional intent to displace the Arbitration Act . . . . the difference [is only] in tone.” Belton, 2020 WL 3240593, at *3. All Epic means is that the text of the statutes controls if it clearly points in one direction; failing such an unequivocal statutory directive, courts are free to use the other tests of McMahon. Indeed, Epic did not purport to overrule McMahon. Thus, Anderson remains controlling.
The court did considerone further argument by the banks worth attention. The appellants theorized that because the Code gives the bankruptcy court and other courts concurrent jurisdiction to sustain a discharge as an affirmative defense to an action on the debt, arbitrators, to whom the FAA commands reference of a dispute that would otherwise be resolved in a court, are as appropriate as bankruptcy court judges to enforce the discharge injunction.
But the court pointed out that the Beltons were not raising the discharge as an affirmative defense but asking the bankruptcy court to find and sanction a violation of the discharge injunction, noting also that the Second Circuit has not found an alternative remedy for such violations in the form of a private right of action. The court further observed that it and other courts have often found that only the issuing court can enforce and sanction violation of an injunction, in this instance the discharge injunction. As the court noted, that is the reasoning behind cases that have rejected class actions for violation of the discharge injunction or the automatic stay. See, e.g., Walls v. Wells Fargo Bank, N.A., 276 F.3d 502, 509-10 (9th Cir. 2002). According to the Second Circuit, the issuing court is best situated to assess the conduct involved in light of the proceedings in the underlying bankruptcy case. In this instance, the conflict isn’t really between two statutes, but between the FAA and a fundamental characteristic of a court. Thus, resort to the text alone does not solve the problem. Neither does a review of legislative history. Accordingly, Anderson’s ruling remains controlling.
Putting aside the specific case law for a moment, this is the correct decision for a reason closest to the court’s last rationale discussed above. Violation of an injunction paradigmatically is a matter for the issuing court to address because such a violation goes to the heart of the court’s dignity and power. Indeed, in the bankruptcy context, in dicta, the Second Circuit noted that courts have generally found that class actions for violations of the discharge injunction or automatic stay are inappropriate because courts other than the issuing court may otherwise thereby be purporting to enforce the injunction.
Even less than another bankruptcy judge or state court judge who are strangers to the injunction, an arbitrator is not the right official to adjudicate and remedy a violation of the discharge injunction. Arguably, this resort to traditional jurisprudence moots the entire analysis raised by McMahon because the conflict on its face is not between statutes, but between a statute (the FAA) and the traditional, inherent power of a court. If that is so, the Second Circuit mixed textual apples and jurisprudential oranges from the start. Ultimately, in Belton (and Anderson)the conflict isn’t really between two statutes, but between the FAA and a fundamental characteristic of a court. Thus, resort to the what McMahon and what it does or does not mean or prescribe does not solve the problem.
One final point is that although the Second Circuit opinion’s dicta refers at some length to cases rejecting class actions for violation of the discharge injunction and automatic stay, the opinion expressly reserves that issue for another day. However, it would be surprising for the court to rule otherwise if ever presented with the question.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.