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21 March 2014
International arbitration and US bankruptcy proceedings are in tension. A key goal of bankruptcy is the centralisation of disputes into one forum, while arbitration encourages decentralisation. US courts balancing these competing impulses have taken a variety of approaches. For decades, international arbitration enjoyed enhanced standing in US bankruptcy proceedings, while domestic arbitration was subjected to a different analysis. More recently, bankruptcy courts have treated international and domestic arbitration clauses equally. Both are enforced by US bankruptcy courts for peripheral disputes, but not for disputes central to the bankruptcy. However, change is in the air yet again. The 2011 Supreme Court decision in Stern v Marshall, which questioned the jurisdictional underpinnings of US bankruptcy courts, is now causing further changes to how arbitration is treated in bankruptcy.
Strong recognition of international arbitration in 1970s and 1980s
In 1970 the United States implemented the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention).(1) Shortly thereafter, the Supreme Court issued several decisions recognising the international nature of trade and commerce and the need to legitimise legal structures supporting such activity. In M/S Bremen v Zapata Off-Shore Co – a 1972 case addressing contractual forum selection clauses – the Supreme Court noted that:
"The expansion of American business and industry will hardly be encouraged if, notwithstanding solemn contracts, we insist on a parochial concept that all disputes must be resolved under our laws and in our courts… We cannot have trade and commerce in world markets and international waters exclusively on our terms, governed by our laws, and resolved in our courts."(2)
The court applied this same rationale two years later in Scherk v Alberto-Culver Co, holding that a claim under the Securities Exchange Act of 1934 was arbitrable under an international arbitration agreement. The court reasoned that the refusal to enforce arbitration clauses in international agreements "would surely damage the fabric of international commerce and trade, and imperil the willingness and ability of businessmen to enter into international commercial agreements".(3)
The New York Convention and these Supreme Court decisions were influential in early cases where international arbitration arose in a bankruptcy context. For example, in In re Hart Ski Mfg Co, a bankruptcy court directed parties to arbitrate a dispute about a creditor's claim and a debtor's counterclaim before the International Chamber of Commerce.(4) Citing Scherk, the Hart Ski court explained that "[f]ederal law and federal policy unequivocally support the enforcement of private arbitration agreements entered into by citizens of the United States and foreign nationals".(5) The Hart Ski court also noted that the New York Convention was implemented by federal statute to "encourage arbitration [of] disputes arising out of transactions by American businessmen in foreign countries".(6)
Solicitude for international business reached a high point in Societe Nationale Algerienne v Distrigas Corp, in which a district court referred a dispute over damages incurred by an Algerian supplier of natural gas to arbitration when a US debtor rejected the contract.(7) The district court reviewed what it described as "a line of United States Supreme Court opinions which enthusiastically endorse an internationalist approach" and "eschew the parochial tendencies of domestic tribunals in retaining jurisdiction over international commercial disputes".(8) Balancing bankruptcy policy against the public policy supporting international arbitration, the Distrigas court chose arbitration decisively:
"In weighing the strong public policy favoring international arbitration with any countervailing potential harm to bankruptcy policy upon the present facts, this Court finds the scales weighted in favor of arbitration… While international arbitration will require a temporary and limited incursion into the Bankruptcy Court's exclusive jurisdictional bailiwick, no bankruptcy policies will suffer adverse impact. Conversely, the very image of the United States in the international business community stands to be tarnished."(9)
As in Hart Ski, the Distrigas court cited the New York Convention and Scherk.(10)
Parity with domestic arbitration in 1990s and after
More recently, however, US bankruptcy courts have treated international arbitration with less deference, applying the same principles that govern enforcement of domestic arbitration agreements.(11)The Second Circuit's 1999 decision in In re US Lines(12) is an example that has proven influential. In US Lines a post-bankruptcy trust filed an insurance coverage action against foreign insurers of a debtor; the insurers moved to have the dispute referred to arbitration. Like earlier courts, the US Lines court balanced bankruptcy policy against the policy favouring international arbitration. It discussed the tensions between the centralising theme of bankruptcy and arbitration's contrary impulse and recognised that this can present a conflict of "polar extremes".(13)
However, the Second Circuit did not display the same reverence for international comity as cases such as Hart Ski. While it recognised that arbitration is favoured in the US judicial system, and "[t]he arbitration preference is particularly strong for international arbitration agreements", the Second Circuit also held that international comity did not require a bankruptcy court to send disputes to international arbitration.(14) It noted that the New York Convention contemplated exceptions to arbitration grounded in domestic law. Accordingly, it found that "[i]n the bankruptcy setting, congressional intent to permit a bankruptcy court to enjoin arbitration is sufficiently clear to override even international arbitration agreements".(15) Applying the principles that had been developed to deal with domestic arbitration clauses in bankruptcy, the Second Circuit concluded that, because the dispute was "integral to the bankruptcy court's ability to preserve and equitably distribute… assets", international arbitration would be inappropriate.(16)
Since then, US courts have generally followed US Lines, harmonising the treatment of domestic and international arbitration agreements. For example, in In re White Mountain Mining Co, the Fourth Circuit considered whether a bankruptcy court had properly denied arbitration of a dispute about a Swiss trust's investment in a debtor.(17) Like the Second Circuit in US Lines, the Fourth Circuit acknowledged that the policy preference for enforcement of arbitration agreements "applies with special force in the field of international commerce" because the United States has acceded to the New York Convention. However, explicitly following US Lines, the court found that the convention contemplates exceptions grounded in domestic law.(18) The Fourth Circuit concluded the case fell into such an exception:
"The inherent conflict between arbitration and the purposes of the Bankruptcy Code is revealed clearly in this case, in which both the adversary proceeding and the London arbitration involved the core issue of whether Phillips's advances to the debtor were debt or equity. The bankruptcy court concluded that ordering arbitration and staying the adversary proceeding would substantially interfere with [the debtor's] efforts to reorganize."(19)
The court also found it compelling that allowing the court proceeding – in contrast to arbitration – would allow all creditors, owners and parties in interest to participate in a "centralized proceeding at a minimum of cost".(20) Accordingly, the Fourth Circuit affirmed the denial of arbitration.
Whether a dispute involving a debtor in a US bankruptcy proceeding is subject to arbitration –domestic or international – is a question that has not yielded clear answers. The question pits the Federal Arbitration Act,(21) which serves to move disputes covered by an arbitration agreement from the courts to arbitration, against the Bankruptcy Code, which centralises disputes involving a debtor in the bankruptcy court. The standard for resolving this statutory conflict is found in the Supreme Court case Shearson/American Express Inc v McMahon, which holds that for a party to successfully challenge a valid arbitration provision, it must demonstrate that either the claims arose under a statute that overrides the provisions of the Federal Arbitration Act or an "irreconcilable conflict" exists between arbitration and the substantive statute's "underlying purposes".(22) Therefore, in bankruptcy, courts have to consider whether enforcing an arbitration clause as required by the Federal Arbitration Act would jeopardise the underlying purposes of the Bankruptcy Code.(23)
At a descriptive level, disputes that are peripheral to bankruptcy are more likely to be arbitrated, while disputes that affect the outcome of the bankruptcy are more likely to be retained by the courts. The theoretical basis for this distinction is less clear. Many courts have suggested that the jurisdictional distinction between 'core' and 'non-core' matters first articulated in Marathon Pipe,(24) and later incorporated into the statutory grant of jurisdiction to bankruptcy courts, can be used to sort arbitrable from non-arbitrable disputes. Core matters are those in which full adjudicatory authority – the power to issue judgments and orders – is vested by statute in bankruptcy courts.(25) The Bankruptcy Code provides a non-exclusive list of core proceedings at 28 USC §157(b)(2)(A-P). For example, core matters include the allowance or disallowance of claims against the estate, and matters that arise under the relevant sections of the Bankruptcy Code itself. By contrast, in non-core proceedings a bankruptcy court may not issue final judgments or orders, but instead must present proposed orders to the district court. Invoking this distinction, courts have held that core bankruptcy matters cannot be arbitrated, while non-core matters must be.(26)
Other courts have suggested that the distinction between core and non-core is not determinative. For example, in In re Thorpe Insulation Co the Ninth Circuit recently found that:
"the core/non-core distinction, though relevant, is not alone dispositive… even in a core proceeding, the McMahon standard must be met – that is, a bankruptcy court has discretion to decline to enforce an otherwise applicable arbitration provision only if arbitration would conflict with the underlying purposes of the bankruptcy code." (27)
Courts have also held that some non-core matters may not be arbitrable.(28) In practical terms, whether a matter is core or non-core does not always answer the arbitration question.
Some have attempted to retain the core/non-core analysis, but have refined it by suggesting that core matters may be further subdivided into 'procedurally core' and 'substantively core' matters. For example, the court in In re Hagerstown Fiber observed that objections to proofs of claim, or ordinary pre-petition contract disputes, while core, are examples of 'procedurally core' matters that may be arbitrable without conflicting with the purposes of the Bankruptcy Code.(29) On the other hand, matters involving 'substantively core' rights created by the Bankruptcy Code itself present a greater likelihood of conflict, and so are generally not arbitrable.(30)
Beyond the core/non-core distinction, other principles have proven important in deciding arbitrability.
Importance of dispute
Bankruptcy courts operate at a practical level. Disputes that are not significant enough to disrupt the overall resolution of the bankruptcy are more likely to be subjected to arbitration. For example, the court in In re Consolidated FGH Liquidating Trust found that, while allowance or disallowance of a claim is a core proceeding, if the allowance or disallowance would have a minimal impact on the other creditors, the arbitration clause can be enforced.(31)
Burden of avoiding arbitration clause
Shearson/American Express assigned the burden of proving conflict with the Bankruptcy Code on the party seeking to avoid an arbitration clause.(32) Courts may use this factor to decide close cases. Although bankruptcy courts are often considered debtor-friendly, even debtors are held to the burden and, if they fail to meet it, the court may enforce arbitration.(33)
Prospect of 'piecemeal' litigation
Courts have considered the effect of sending some, but not all, claims to arbitration. Unfortunately, the impact of this factor is inconsistent. Some courts have found that where several similar disputes present themselves in bankruptcy but only some are governed by arbitration clauses, arbitration should be denied because enforcing an arbitration clause would lead to piecemeal resolution of issues in conflict with the objectives of the Bankruptcy Code.(34) On the other hand, courts may refer some, but not all, claims in an individual dispute to arbitration.(35) Courts have also stayed non-arbitrated claims in deference to arbitrated claims. For example, in Hagerstown Fiber the court stayed certain fraudulent conveyance claims it declined to send to arbitration because "the arbitration may contribute to the resolution of the issues raised by the fraudulent conveyance claims".(36)
The jurisdictional foundations of US bankruptcy courts were recently shaken by the Supreme Court's decision in Stern v Marshall.(37) While Stern did not directly concern arbitration, it raised issues that bankruptcy courts must consider when determining their power to adjudicate cases.
Stern effectively diminished the decision-making power of US bankruptcy courts. In Stern a narrow majority of the Supreme Court held that Article III of the US Constitution prohibited a bankruptcy judge from deciding a compulsory counterclaim for tortious interference brought by a debtor against a creditor. The Supreme Court held that the counterclaim was not part of the bankruptcy claims allowance process and that Congress could not delegate such a matter to a bankruptcy judge.(38) Instead, the court found that the US Constitution allocated such decision-making power to "Article III judges in Article III courts" – that is, to US district courts.(39)
Stern's impact on arbitration in bankruptcy is not yet clear. Courts that have considered the question have viewed Stern's check on bankruptcy court jurisdiction as resulting in a corresponding increase in the scope of disputes that can be arbitrated. For example, in In re TP, Inc, a debtor brought an adversary proceeding against a lender and the lender moved for arbitration of the dispute pursuant to an arbitration clause. The bankruptcy court began with the core/non-core analysis, noting that core disputes cannot be arbitrated.(40) However, the court then applied Stern to distinguish 'constitutionally core' claims from merely 'statutorily core' claims. Constitutionally core claims must either emanate from the bankruptcy proceeding itself or necessarily be resolved in the claims allowance process.(41) Claims must be constitutionally core to escape arbitration.(42)
During this term the Supreme Court will decide a follow-up to Stern, Executive Benefits Insurance Agency v Arkison.(43) Like Stern, the case does not directly involve arbitration; it will address the concept of implied consent to bankruptcy jurisdiction and may have implications for arbitration in bankruptcy. If the Supreme Court emphasises that those that consent to adjudication by the bankruptcy court in non-core matters will be held to their agreements, it may lend impetus to the enforcement of agreements to litigate in a non-judicial forum like arbitration.
For further information on this topic please contact James P Wehner at Caplin & Drysdale, Chartered by telephone (+1 202 862 5000), fax (+1 202 429 3301) or email (email@example.com). The Caplin & Drysdale, Chartered website can be accessed at www.caplindrysdale.com.
(6) Hart Ski Mfg, 18 BR at 161. The pro-international arbitration stance of Hart was followed in other cases of the era. For example, see In re Mor-Ben Ins Mkts Corp, 73 BR 644, 647 (BAP 9th Cir 1987) ("[t]he desirability of an arbitration clause especially in an international transaction agreement is well recognized and must be respected", citing Scherk).
(11) For example, In re Bethlehem Steel Corp, 390 BR 784 (SDNY 2008) (following US Lines to deny arbitration of preference claims against Italian shipping company); In re Salander-O'Reilly Galleries, LLC, 475 BR 9 (SDNY 2012) (denying arbitration of claim of a BVI corporation against debtor gallery regarding Botticelli painting).
(26) For example, In re TP, Inc, 479 BR 373, 382 (Bankr EDNC 2012) (if a matter is non-core, it is generally "referred to arbitration consistent with the policy in favor of arbitration; however if a core proceeding is at issue, the policy in favor of centralized determination in the bankruptcy court generally prevails"); In re Hagerstown Fiber Ltd P'ship, 277 BR 181, 203 (SDNY 2002) ("If the dispute is non-core, that will generally end the inquiry. The bankruptcy court will lack the discretion to refuse to compel arbitration").
(27) In re Thorpe Insulation Co, 671 F3d 1011, 1021 (9th Cir 2012). See also In re Winimo Realty Corp, 270 BR 108, 118 (SDNY 2001) ("a determination that a proceeding is core will not automatically give the bankruptcy court discretion to stay arbitration").
(31) In re Consol FGH Liquidating Trust, 419 BR 636, 649 (Bankr SD Miss 2009); In re Singer Co NV, 2001 WL 984678, at *6 (SDNY August 27 2001) (noting fact that dispute would not affect the allocation of assets as factor suggesting arbitration).
(34) For example, In re APF Co, 264 BR 344 (Bankr D Del 2001); In re Startec Global Commc'ns Corp, 300 BR 244, 254-55 (Bankr D Md 2003) ("[e]nforcing arbitration of only some of these closely related claims would inherently conflict with one of the core purposes of bankruptcy, that is, to 'allow the bankruptcy court to centralize all disputes'") (internal citation omitted).
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James P Wehner