Innvantage  Group, Inc. v. Millie and Severson, Inc. (In re Innvantage Group, Inc.), 2025 WL 715630 (Bankr. N.D. Ill. March 4, 2025)

The United States Bankruptcy Court for the Northern District of Illinois (the Court) recently granted in part and denied in part a motion to compel arbitration of litigation arising out of a construction dispute brought in a subchapter V chapter 11 case. The order allowed an arbitrator to liquidate the amounts the parties owed each other, but the Court retained the power to rule on the debtor’s request for declaratory judgment that the creditor was estopped from asserting the defense of setoff.  Innvantage  Group, Inc. v. Millie and Severson, Inc. (In re Innvantage Group, Inc.), 2025 WL 715630 (Bankr. N.D. Ill. March 4, 2025).  To view the opinion, click here.

Facts

Innvantage Group, Inc. (Innvantage or the debtor) entered into a subcontract agreement with Millie and Severson, Inc. (M&S) in connection with a construction project in Oakland, California.  Innvantage eventually abandoned the project and then filed an arbitration demand against M&S.  M&S responded with a counterclaim against Innvantage in the context of arbitration.  After the parties had selected an arbitrator through the American Arbitration Association (AAA), they set an evidentiary hearing for April 2024.  Before the evidentiary hearing commenced, however, Innvantage filed a subchapter V chapter 11 proceeding in September 2023. AAA then stayed the arbitration.

The debtor filed schedules that listed M&S as an unsecured creditor with a disputed and unliquidated claim   It did not list any litigation claims as assets but did list more than $350,000 as collectible accounts receivable.  The Court entered a bar date order, setting a date of November 27, 2023.  M&S did not file a proof of claim nor did  it object to the proposed operating plan.  The Court confirmed an Amended Plan in May 2024.

In July 2024, the debtor filed an adversary complaint against M&S, requesting entry of judgment for more than $429,000.  It also requested issuance of a declaratory judgment that M&S was estopped from asserting the defense of setoff because it had not filed a proof of claim.  A month later, M&S filed a motion to compel arbitration, based on Paragraph 20 in the subcontract which compelled arbitration as the only allowed Claims Resolution Procedure.  Paragraph 20 also provided that the Federal Arbitration Act (the “Act”) would control, not state arbitration procedures.  In addition to seeking arbitration, M&S asked the Court to dismiss the complaint in its entirety.  The Court granted the motion in part, allowing the arbitrator to liquidate the claim and counterclaim.  However, the Court retained jurisdiction to decide the estoppel/setoff issue.

Reasoning

The Court recognized tension between the Act and the Bankruptcy Code.  The Act generally favors enforcement of an arbitration agreement in commercial disputes.  However, it does not set a national policy favoring arbitration; rather, it enforces arbitration agreements like any other contract.  Contradicting the Act in matters like the one before the Court, the Bankruptcy Code and the cases interpreting it show a bankruptcy court’s jurisdiction is intended to be broad enough  to “deal efficiently and expeditiously with all matters connected with the bankruptcy estate.”  Celotex Corp. v Edwards, 514 U.S. 300, 308 (1995).

M&S is correct that the liquidation of claims and counterclaims arising from a construction contract dispute is well-handled in arbitration. Most construction agreements have arbitration clauses for that reason.  However, the setoff issue, raised by the debtor and briefed by M&S in its reply papers, implicates core bankruptcy issues arising from M&S’s failure to file a proof of claim.  The allowance or disallowance of claims is core bankruptcy jurisdiction.

The confirmed plan here does not rely on collection of receivables to assure debtor’s performance.  Therefore, the liquidation of any claim of M&S, as well as what it might owe the debtor, is best left to arbitration.  However, the setoff issue implicates core issues reserved for the bankruptcy court. For that reason, the legal decision on the estoppel argument will be made by the bankruptcy court after the arbitration has been completed.

Author’s Comments

This is a balanced decision, which gives due respect to the Federal Arbitration Act’s preference for enforcing arbitration clauses when the parties have agreed to resolve disputes in that forum.  However, it recognizes that the effect of failing to file a proof of claim when a debt is listed as unliquidated and disputed is purely one of bankruptcy law.  The split here makes sense.  Balanced rulings such as this one might prevent later cases from allowing blanket arbitration even when core bankruptcy issues are involved. 

[The Commercial Financial Newsletter is written by an ad hoc group of the California Lawyers Association (CLA) Business Law Section. This article was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, CD CA, ret.), a member of the ad hoc group. The opinions contained herein are strictly those of the author.].