United States: To Arbitrate Or Not To Arbitrate, That Is The Question: Enforcing Arbitration Clauses In Bankruptcy

Last Updated: September 25 2019
Article by Paul Hammer

The Federal Arbitration Act, 9 U.S.C. §§ 1-307, represents a federal policy in favor of enforcing arbitration clauses. The Supreme Court has held that courts are generally obligated to enforce arbitration clauses absent a countervailing federal statute. Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220, 226 (1987). However, this policy inevitably comes into conflict with the Bankruptcy Code, which is grounded on a policy of centralized dispute resolution. Congress has not offered any legislative guidance on how to reconcile these competing policies. As a result, the courts have been left to determine when arbitration clauses are enforceable in bankruptcy. An April 16, 2019 ruling in the U.S. Bankruptcy Court for the Northern District of Texas in the case of In re: Acis Capital Management, L.P. addressed this issue, which regularly figures prominently in complex Chapter 11 bankruptcy cases. In denying the defendant's motion to compel arbitration, the court held that it would exercise its discretion to decline to order arbitration, on the ground that the enforcement of the arbitration clause would conflict with the purposes of the Bankruptcy Code.

The Bankruptcy Court Ruling

Procedural background

At issue in Acis Capital Management, L.P. was a request that the bankruptcy court send to arbitration only a sub-set of claims asserted in the subject Adversary Proceeding. The Adversary Proceeding was a large, complex lawsuit involving 35 claims, 20 of which were grounded in fraudulent transfer theories. The Arbitration Motion, as explained below, sought arbitration of eight of the 35 claims.

The Arbitration Motion was filed by party Highland Capital Management, L.P. ("Highland"). Highland and a related company, Highland CLO Funding Ltd. ("HCLOF"), were originally the plaintiffs in the Adversary Proceeding, suing the Chapter 11 Trustee for injunctive relief (arguing that the Chapter 11 Trustee was interfering with their business rights and decisions, essentially). The Chapter 11 Trustee fired back with 35 counterclaims against Highland and HCLOF (adding three parties related to Highland as third-party defendants with regard to some of those 35 counterclaims). Notably, these 35 counterclaims—as directed toward Highland—were also alleged to be objections to Highland’s two $ 4,672,140.38 proofs of claim filed in the underlying bankruptcy cases. In that regard, the Chapter 11 Trustee stated that its Answer and Counterclaims included "an objection to Highland Capital’s proofs of claim pursuant to Federal Rule of Bankruptcy Procedure 3007(b), and the counterclaims asserted herein shall constitute recoupment and/or offset to such proofs of claim, to the extent such claims are otherwise allowed." In fact, after the 35 counts were articulated in the Chapter 11 Trustee’s Answer and Counterclaims, there were 20 articulating the Chapter 11 Trustee’s objections to Highland’s proofs of claim.

The Chapter 11 Trustee ultimately proposed and obtained confirmation of a Chapter 11 plan in the underlying bankruptcy cases, and the Reorganized Debtors, now under new ownership and management, were vested in that plan with the counterclaims in this Adversary Proceeding (among other rights and claims). The injunctive relief initially sought by Highland and HCLOF, as plaintiffs in the Adversary Proceeding, later became mooted by various orders in the bankruptcy cases and such claims were voluntarily dismissed without prejudice. Thus, Highland, which pursued the Arbitration Motion, wore the hat of only a defendant (and proof of claimant), and the Reorganized Debtors were the plaintiffs asserting the 35 original "counterclaims" asserted by the Chapter 11 Trustee against Highland. The Reorganized Debtors were Acis Capital Management, L.P. and Acis Capital Management GP, LLC, and they opposed the Arbitration Motion.

Analysis – Denial of Arbitration Motion

Citing to the Federal Arbitration Act (the "FAA"), 9 U.S.C. § 1 et seq., Highland argued that the bankruptcy court must enter an order compelling arbitration as to counts 1-8 because:

(a) these eight counts revolve around the interpretation of Sub-Advisory and Shared Services Agreements; and

(b) the aforementioned Agreements contained binding arbitration clauses.

Highland also requested that the Adversary Proceeding be stayed regarding counts 1-8, pending binding arbitration. The Reorganized Debtors urged that, even if there are applicable arbitration clauses, the court may and should exercise discretion and decline to order arbitration, since core bankruptcy matters are involved and arbitration would conflict with the purposes of the Bankruptcy Code.

In denying the Arbitration Motion, the court instructed that a bankruptcy court may decline to enforce arbitration clauses when it finds:

(a) the underlying nature of the proceeding derives from the provisions of the Bankruptcy Code; and

(b) that enforcement of the arbitration provision would conflict with the purposes/goals of the Bankruptcy Code.

It was noted that some purposes/goals of the Code that might support a denial of arbitration, include:

(1) the equitable and expeditious distribution of assets of the Debtor’s estate;

(2) centralized resolution of pure bankruptcy issues;

(3) protection of creditors and reorganizing debtors from piecemeal litigation, and

(4) the undisputed power of a bankruptcy court to enforce its orders.

Ultimately, the court believed that the Adversary Proceeding—more than anything else—sought avoidance of fraudulent transfers; and, such avoidance theories derive from Sections 544(a), 547, 548 and 550 of the Bankruptcy Code. Enforcing the arbitration clause would have conflicted with the purposes of the Bankruptcy Code—one of the central purposes of which is the expeditious and equitable distribution of the assets of a debtor’s estate. The avoidance actions in the Adversary Proceeding were found to predominate over all other counts and the importance of the federal bankruptcy forum provided by the Code was, in the court's view "at its zenith." That is, arbitrating Counts 1-8 would have seriously jeopardized the Adversary Proceeding because they are an integral part of determining Highland’s proofs of claim and the other core counts in the Adversary Proceeding. The bankruptcy court’s quintessential duties are to adjudicate proofs of claim and to provide a central forum for litigation, whenever feasible and jurisdictionally sound. Indeed, the court noted that, when a proof of claim is filed,
"one of the peculiar powers of a bankruptcy court has been invoked".


The bottom line is that, in attempting to avoid arbitration clauses, creditors in the 5th Circuit would be best served to file timely proofs of claim, hence strengthening their ability to argue that the jurisdiction and powers of the court have been invoked. Such a position would increase the chances of keeping the matter before the bankruptcy judge. On the other hand, if arbitrating a matter is desired, creditors should consider other strategic factors, including, but not limited to, not filing a formal proof of claim with the claims registry. In any event, proper planning with a bankruptcy professional is paramount to ensure that creditors are maximally protecting their interests in a bankruptcy proceeding.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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