The following is a case update written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, analyzing a recent decision of interest:
The U.S. Bankruptcy Court for the Southern District of New York held that fraudulent transfer and turnover claims are “core” non-arbitrable claims and denied a motion to compel arbitration as to those claims. Pereira v. Urthbox, Inc., et al. (In re Try the World, Inc.), 2021 WL 3502607 (Bankr. S.D.N.Y. 8/9/21).
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Try the World, Inc. (the debtor), a snack food box delivery service, entered into an asset purchase agreement (APA) to sell substantially all of its assets to Urthbox LLC (“Urthbox”), another snack food service. The APA included a broad arbitration clause. Less than one year later, the debtor filed a chapter 7 bankruptcy case and the bankruptcy trustee filed an adversary proceeding against Urthbox, the debtor’s principals and others. The claims included fraudulent transfer claims under the Bankruptcy Code and state law, accounting/turnover, claim disallowance, unjust enrichment and breach of contract. Urthbox filed a motion to dismiss the claims, or, in the alternative, to stay prosecution pending arbitration of the arbitrable claims.
The court cited to Genesco, Inc. v. Kakiuchi & Co., Ltd., 815 F.2d 840, 844 (2nd Cir. 1987), stating that on motions to compel arbitration, the court must consider “(1) whether the parties agreed to arbitrate; (2) whether the dispute falls within their arbitration clause; (3) if federal statutory claims are raised, whether Congress intend [sic] those claims to be arbitrable; and (4) if the court concludes that some but not all of the claims are arbitrable, whether it should stay the non-arbitrable claims pending the conclusion of the arbitration.” In conducting the analysis, the court determined arbitrability on a claim-by-claim basis. The court noted that “[i]n considering whether a claim is subject to an otherwise enforceable arbitration clause, courts focus on two factors: (i) whether the claim arises in a core or non-core proceeding, and (ii) if the claim is core, whether any underlying purpose of the Bankruptcy Code would be adversely affected by enforcing the arbitration clause.”
Citing to Kittay v. Landegger (In re Hagerstown Fiber P’ship), 277 B.R. 181, 202 (Bankr. S.D.N.Y. 2002), the court stated that the court has the discretion to refuse arbitration where the dispute concerns rights under the Bankruptcy Code, but does not have discretion otherwise. However, the court noted that even “[c]ore claims are not automatically excepted from the reach of otherwise enforceable arbitration clauses. If the claim is core, ‘the bankruptcy court must still carefully determine whether any underlying purpose of the Bankruptcy Code would be adversely affected by enforcing the arbitration clause,’ and the ‘arbitration clause should be enforced unless [doing so] would seriously jeopardize the objectives of the Code.’”
The court determined that the fraudulent transfer claims asserted by the trustee “belong to creditors,” are “a quintessential right” of the trustee, and the trustee was not bound by the arbitration provision. The court reasoned that “[t]he creditors are not parties to the APA and, as such, the Arbitration Clause is not binding on them.” Further, the court made clear that “even if the Trustee had agreed to arbitrate the fraudulent transfer claims and those disputes fell within the scope of the Arbitration Clause, the Court would nonetheless exercise its discretion to deny arbitration on the basis that fraudulent transfer claims are substantively core and that ‘arbitrating the dispute would severely conflict with relevant provisions of the Bankruptcy Code.’”
Even though Urthbox did not file a proof of claim, the trustee’s disallowance claim pursuant to Section 502(d) was included in the complaint to the extent that the trustee prevailed on the fraudulent transfer claims and amounts were paid by Urthbox to the estate. The court determined that for the same reasons as the fraudulent transfer claims, the “claim is non-arbitrable as it is not a claim that the parties chose to arbitrate,” is “a creature of the Bankruptcy Code” and “is substantively core and directly relates to the administration of the estate.” The court similarly noted as to the turnover claim that it is a core claim for which the court would not compel arbitration.
However, the court’s analysis was different as to the breach of contract and unjust enrichment claims. The court determined that the breach of contract claim “is arbitrable because ‘a breach of contract action by a debtor against a party to a pre-petition contract, who has filed no claim with the bankruptcy court, is non-core.’” Similarly, the court determined that the unjust enrichment claim could have been pursued outside of the bankruptcy case and is likely non-core (some courts sometimes find the claim is core if it is intimately intertwined with core claims or arose out of the same facts as a proof of claim, but those circumstances are not present in this case). Therefore, the court determined that the court likely did not have discretion to hear the non-core unjust enrichment claim.
In regard to whether the court would stay any of the claims while arbitration proceeded as to the breach of contract and unjust enrichment claims, the court cited to Hagerstown and stated that “[t]he decision to stay non-arbitrable claims is ‘committed to the court’s discretion’” and “is appropriate if: (1) ‘the arbitrable claims predominate the lawsuit and the non-arbitrable claims are of questionable merit’ or (2) ‘the stay will promote judicial economy, avoidance of confusion and possible inconsistent results without working an undue hardship or prejudice against the plaintiff.” Here, the court determined that “[t]he arbitrable claims do not predominate this lawsuit” and that, as to the accounting/turnover claim, “[t]he issuance of a stay would conflict with the Trustee’s core obligation to marshal and liquidate the assets expeditiously and investigate and report on the financial affairs of the debtor.” The court likewise declined to stay the fraudulent transfer claims because “[c]ompelling the Trustee to arbitrate the non-core claims before the Court resolves the Fraudulent Transfer Claims” conflicts with the Bankruptcy Code.
The court also denied Urthbox’s motion to dismiss the fraudulent transfer claims, determining that the actual intent fraudulent transfer claims adequately alleged badges of fraud and that the constructive fraudulent transfer claims adequately alleged insufficient consideration for the APA. The court therefore denied the motion to dismiss, granted the motion to compel arbitration of the breach of contract and unjust enrichment claims and denied the motion to compel arbitration of the fraudulent transfer and accounting/turnover claims. The court further denied the request to stay the non-arbitrable fraudulent transfer and accounting/turnover claims.
The bankruptcy court’s determination that fraudulent transfer claims are the claims of creditors, not the debtor, and therefore are not subject to pre-petition arbitration agreements entered into by the debtor is well-reasoned and is in accord with the Ninth Circuit. The Ninth Circuit held that as to fraudulent transfer claims, “the Trustee stands in the shoes of the creditors, not the debtors. Only the parties to an arbitration agreement are bound by it”and that “arbitration agreements signed by the debtors cannot apply to claims under § 544 or California Civil Code section 3439.04.” In re EPD Inv. Co., LLC, 821 F.3d 1146, 1152 (9th Cir. 2016).
In practice, bankruptcy courts have significant expertise in hearing and determining core bankruptcy claims and are likely to deny motions to compel arbitration as to those claims given that permitting arbitration will generally conflict with the underlying purposes of the Bankruptcy Code. Permitting arbitration of a core claim for disallowance of claim would place a paid private arbitrator (who may lack judicial experience), rather than a federal judge, in the position of being able to determine validity, priority and amounts of claims and therefore greatly affect ability of bankruptcy courts to make determinations impacting the administration of, and distributions in, bankruptcy cases. Permitting arbitration of turnover claims would also shift core functions of bankruptcy courts to a private arbitrator. However, even if a claim is core, such as disallowance of a claim, bankruptcy courts may permit arbitration where the amount of the claim must be determined under non-bankruptcy law for which the court lacks expertise. In those cases, bankruptcy courts may refer the claim to arbitration to determine the amount of the claim. Where arbitration clauses are present in pre-petition agreements, bankruptcy trustees will look closely at whether to include non-core (or potentially non-core) claims given that if arbitration is compelled, the estate’s costs will increase greatly and uncertainty will rise, driven by a non-judicial officer making determinations in the case.
These materials were written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, a member of the ad hoc group and the Immediate Past Chair of the CLA Business Law Section, with editorial contributions by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), also 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.