The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, analyzing a recent decision of interest:
In In re Project Restore, LLC, 2022 Bankr. LEXIS 2868, 2022 WL 6233552 (Bankr. M.D. Tenn. 2022) (“Project Restore”), the United States Bankruptcy Court for the Middle District of Tennessee (the “Bankruptcy Court”) rejected the debtor’s claims that the involuntary petition against it had to be submitted to arbitration because a clause in each of its contracts with the petitioning creditors mandated arbitration of disputes and that in any case the Bankruptcy Court should abstain from hearing the petition in deference to the federal policy of encouraging arbitration.
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The debtor signed construction contracts with three parties. Each contract mandated arbitration of disputes regarding the contract, two naming the American Arbitration Association (the “AAA”) as the forum, one specifying JAMS. The creditors brought an involuntary petition against the debtor. Bankruptcy Code (the “Code”) section 303(b)(1) provides that to qualify as one of the minimum of three petitioning creditors bringing an involuntary petition, a creditor must have a claim of at least $18,600 that “is not contingent as to liability or the subject of a bona fide dispute as to liability or amount.” As a preliminary matter, the Bankruptcy Court noted that the governing Sixth Circuit has held that in considering an involuntary petition, a bankruptcy court need only determine that there is such a dispute to disqualify a petitioner; it need not resolve the conflict.
The debtor moved to dismiss the petition, arguing that since there was a dispute with each of the creditors as to exact amount of the debt involved, there was a bona fide dispute that disqualified each of them from being a petitioning creditor, even though the debtor needed only to bounce one of the creditors to defeat the petition since three are required. Furthermore, relying on the contracts’ terms and the Federal Arbitration Act (the “FAA”), the debtor also moved the Bankruptcy Court to either require that the petition be adjudicated by arbitration or that it abstain from the petition. The Bankruptcy Court denied both motions.
In denying the motion to dismiss because the claims of each creditor (let alone just one of the three) were allegedly subject to a bona fide dispute, the Court pointed out that this theory produces skewed results. If a creditor asserted a claim of $50,001 but the debtor disputed but a dollar of it, the debtor’s position would be that a creditor with a claim that was uncontested for $50,000 but disputed for but that additional dollar would not qualify as a petitioning creditor. The Bankruptcy Court also rejected the debtor’s argument that if it considered the petition, it would have to decide issues about the claim on the merits that would impinge on issues that might be sent to arbitration if the Bankruptcy Court later sent any claim objection proceeding to arbitration. Here, the court simply noted that it would not have to decide all aspects of a creditor’s claim and the debtor’s defenses and counterclaims simply to be able to determine whether the creditor had a cognizable claim of at least $18.600.
Moving to whether the petition itself should be sent to arbitration, the Bankruptcy Court reasoned against the backdrop of the treatment in bankruptcy of cases otherwise covered by the FAA’s mandatory arbitration provision. The FAA provides that arbitration agreements “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. §2 The FAA adds that the court, “upon being satisfied that the issue involved in such suit or proceeding is referable to arbitration under such an agreement, shall on application of one of the parties stay the trial of the action until such arbitration has been had in accordance with the terms of the agreement * * * *. 9 U.S.C. §3.
The Supreme Court has explained that to determine whether arbitration is appropriate at all:
[W]e first ask whether the parties agreed to submit their claims to arbitration, and then ask whether Congress has evinced an intention to preclude a waiver of judicial remedies for the statutory rights at issue.
See Alabama v. Randolph, 531 U.S. 79, 90 (2000). Moreover, in Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 226-27 (1987), the Supreme Court has provided additional guidance, stating:
Like any statutory directive, the Arbitration Act’s mandate may be overridden by a contrary congressional command. The burden is on the party opposing arbitration, however, to show that Congress intended to preclude a waiver of judicial remedies for the statutory rights at issue * * * *. If Congress did intend to limit or prohibit waiver of a judicial forum for a particular claim, such an intent will be deducible from the statute’s text or legislative history or from an inherent conflict between arbitration and the statute’s underlying purposes.
As the Bankruptcy Court observed, cases tend to find there is an “inherent conflict” between arbitration and bankruptcy court jurisdiction when “‘the claims at the center of the dispute were directly related to the Bankruptcy Code.’” [Citations omitted.]
The Bankruptcy Court contrasted the FAA’s policy to promote nonjudicial resolution of disputes through arbitration with Congress’s obvious intent to centralize bankruptcy-related proceedings in the bankruptcy courts. The Bankruptcy Court characterized the situation as reflecting the virtual opposites of centralization in bankruptcy versus decentralization via arbitration. Moreover, it is hard to conceive of a matter more directly related to the Bankruptcy Code than the proceeding that launches everything bankruptcy.
The court then pointed out some consequences of the debtor’s position that weighed heavily against the notion that an involuntary bankruptcy petition could be sent to arbitration. One is that would mean that a creditor could file a involuntary petition before an arbitrator in the first instance, even against a debtor’s wishes. But there is no indication that Congress intended an arbitrator to enter an order for relief if it granted the petition.
The Bankruptcy Court’s decision is correct. In addition to the reasons that court advanced, there are others. If the arbitration could grant an order for relief, could it conduct the bankruptcy case? Not even the FAA would seem to authorize that, since the disputes to which the underlying contracts refer arbitration only relate to the contracts, but not to the debtor’s relationships to all of its other creditors, let alone disposition of the debtor’s assets, and other matters. Nor is there any indication that Congress intended any court but the district courts or bankruptcy courts to conduct bankruptcy cases. See 28 U.S.C. § 1334(a) (b) (district court have “original and exclusive jurisdiction of all cases under title 11”) (emphasis added); 28 U.S.C. §§ 157(a) & (b) (district courts can refer bankruptcy cases and proceedings to bankruptcy courts). Indeed, there probably can be no better example of a dispute that is “‘directly related to the Bankruptcy Code’” than whether to commence a case against the will of the prospective debtor. Finally, implicit in Project Restore is another question that make arbitration of an involuntary petition doubtful. Which of the two providers, JAMS or AAA, would conduct the mediation? By the same token, what if less than all of the the petitioning creditors had arbitration clauses in their contracts with the debtor. Which forum, bankruptcy court or arbitration, would govern? In short, there is a plethora of reasons why arbitration is not the appropriate situs of an involuntary petition.
Nor is the debtor’s claim that a bankruptcy court’s deciding some factual or legal issues in ruling on an involuntary petition is an interference with an arbitrator’s jurisdiction over the dispute if the claim resolution itself later is transferred by the bankruptcy court to arbitration. If the commencement of a bankruptcy case is given by Congress exclusively to the bankruptcy or district courts, which it clearly is because those courts have “exclusive” jurisdiction over all bankruptcy cases, then Congress clearly has granted those federal courts the right to ‘intrude’ on the arbitration rights of a party, at least to that extent. Incidentally, the Bankruptcy Court’s dismissal of this issue as being simply like the granting of partial summary judgment that does not interfere with the arbitration is not convincing; it does take some arbitrable issues out of the arbitrator’s hands. But that result is the consequence of Congress’s granting certain kinds of jurisdiction to the district and bankruptcy courts, its having done so being a decisive indicator of its intent to thereby limit the application of the FAA.
This review was written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, 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.
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