Lawniczak on a Bankruptcy Party's Right to Arbitration

Lawniczak on a Bankruptcy Party's Right to Arbitration

EXCERPT (note-links to statutes below are accessible by lexis.com subscribers): When Is a Party in a Bankruptcy Case Entitled to Arbitration?

In general, agreements to arbitrate are enforceable. There is an exception when the purpose of a congressional act, such as title 11 of the United States Code, would be thwarted by the arbitration. Thus, a bankruptcy court can only reject an agreement to arbitrate on a finding that such arbitration would materially conflict with the purposes of the Bankruptcy Code.

The Final Resolution of the Arbitration Issue in Thorpe

Once the Continental Ins. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 671 F.3d 1011 (9th Cir. Cal. 2012) case established the test for when arbitration would not be compelled, it flowed easily that the facts in the case were such that arbitration should not have been allowed. The court noted (1) the important role of Bankruptcy Code § 524(g) related to the creation of asbestos trusts, which was implicated by Continental's claim, 671 F.3d at 1022, (2) the purpose of centralization of disputes in one forum and protecting debtors from piecemeal litigation, id., and (3) the very nature of Continental's claim, which was based in part on the decision to seek bankruptcy protection and invoke § 524(g), id. at 1023-24. Indeed, a primary basis for the Thorpe court's agreement with the bankruptcy court that the Continental claim to arbitration should be rejected was the fact that the claim was based upon Thorpe's exercise of its rights under bankruptcy law following execution of the settlement agreement between Thorpe and Continental. 671 F.3d at 1025-26.

The Disallowance of the Continental Claim by Invalidating the Contractual Provisions Limiting Bankruptcy Rights

The last issue that the Thorpe court faced was whether the bankruptcy court correctly disallowed Continental's claim. Here again, the court focused on the fact that the settlement agreement that Continental was relying upon as the basis for its claim limited Thorpe's ability to exercise its rights under bankruptcy law. 671 F.3d at 1025-26. The court determined that such agreements are unenforceable as against public policy because otherwise "astute creditors would routinely require their debtors to waive." Bank of China v. Huang (In re Huang), 275 F.3d 1173, 1177 (9th Cir. 2002) (prepetition agreement that debt will be nondischargeable if a subsequent bankruptcy proceeding is filed is unenforceable). See generally 12 Business Organizations with Tax Planning §§ 156.05, 157.02[8][b] (Lexis 2011). Thus, the Thorpe court affirmed the bankruptcy court in its decision to disallow the Continental claim.

Conclusion

We learn from the Thorpe case that the right to arbitrate based on a prepetition agreement is not absolute. When the issues that will be arbitrated are core matters central to the bankruptcy process, as they were in Thorpe, the bankruptcy court should not send the matter out for arbitration but rather should decide the matter in the bankruptcy proceeding itself.

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