ADR Meets Bankruptcy, Part 3 – Enforcing Arbitration Agreements

At the ADR Meets Bankruptcy conference at St. John’s, I sat on a panel with Steve Ware and Marianne Culhane that addressed the enforcement of pre-petition arbitration agreements in bankruptcy.  The panel was moderated by Alan Resnick, who had written on the topic a couple of years ago.

Several interesting points came out of the discussion.  Steve started off and explained why parties to a dispute in bankruptcy lose their jury rights but not their arbitration rights.  The apparent anomaly occurs because bankruptcy is deemed to be an equitable process.  Parties do not have the right to a jury in equity.  But courts of equity enforce contractual rights and obligations to the same extent as courts of law.  So filing proof of a claim in bankruptcy extinguishes the right to a jury, yet leaves the contractual obligation to arbitrate intact.

Steve Ware & Marianne Culhane
Steve Ware & Marianne Culhane

Marianne picked up from there, and expressed concern that courts might be too willing to enforce contractual arbitration agreements, at least of “core” bankruptcy matters (loosely, those that arise in or under the Bankruptcy Code instead of as a matter of other state or federal laws).  Her concern is that arbitration could be used as a way to escape the mandatory provisions of the bankruptcy code.  She favors a legislative reform, along lines proposed by Alan, making arbitration agreements unenforceable in all core proceedings.

I argued that that fix goes further than needed to protect the integrity of the bankruptcy process while still respecting arbitral agreements.  In a nutshell, I favor broad enforcement of arbitration agreements with oversight to ensure that the costs of arbitration are not excessive and that awards do not compromise the policy objectives of the bankruptcy system.  I explain all that in more detail in may paper, available here.

Paul Kirgis
Paul Kirgis

Probably the most interesting thing I learned in studying arbitration in bankruptcy involves the difference in the treatment of Shearson v. McMahon in the bankruptcy literature as compared to the arbitration literature.  Bankruptcy courts and scholars have interpreted McMahon to provide essentially a balancing test that gives courts license to weigh the interests of the bankruptcy system against the interest in promoting arbitration, for the purpose of deciding whether to enforce arbitration agreements.  Dozens of bankruptcy cases use McMahon in this way.  The bankruptcy courts see it as controlling authority on the enforceability of arbitration agreements, and they routinely refuse to enforce agreements based on its “test”.

I think it is safe to say that no arbitration scholar would understand McMahon to give courts discretion to decline to enforce arbitration agreements.  We in the ADR field tend to see McMahon is just one in a line of cases establishing that any claim based on federal statutory law is arbitrable.  The case is not exactly an afterthought, but it is also not one with especial significance standing alone.  And it certainly does not confer discretion to reject otherwise valid arbitration agreements.

Bankruptcy often seems like a world unto itself, as I have discovered.  It has adapted procedural rules in ways that at times seem antithetical to traditional notions of due process; here it seems to have adapted a substantive precedent in a way that defies common understandings.  There is a temptation—for me at least—to conclude that district courts are “misusing” McMahon.  But of course, that isn’t possible.  Law is not that determinate.  The case means whatever courts say it means.  Still, at a minimum, it is fascinating to see how a single decision can have such different meanings in different contexts.

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