Alternative Dispute Resolution Processes and the Bankruptcy Courts
The Business Advisor
April 11, 2003
Alternative Dispute Resolution (“ADR”), such as AAA mediation and arbitration, has become widely accepted in both the legal and business worlds as an economical and speedy alternative to litigation. Sophisticated business people rely upon privately administered ADR to resolve business disputes instead of resorting to commercial litigation in the public courts. As a result, arbitration and mediation clauses in contracts have become common, and in some industries, standard.
Both federal and state courts and legislatures encourage and enforce the use of arbitration and mediation provisions in contracts. However, the presence of these clauses can create difficulties when disputes arise during the course of a bankruptcy proceeding in Bankruptcy Court. Friction may arise between the policy of encouraging ADR, embodied, among other places, in the Federal Arbitration Act, 9 U.S.C. Section 1, et seq., and the Bankruptcy Code’s policy of granting jurisdiction over bankruptcy related disputes to the Bankruptcy Courts. The question thus arises whether a bankruptcy judge may decide an insolvency-related dispute when the parties have entered into a contract designating arbitration or mediation as the forum of choice.
The practice of referring disputes between parties to arbitration began with the passage of the Federal Arbitration Act in 1947. Since then, courts have interpreted the Federal Arbitration Act as promoting a “liberal policy favoring arbitration.” This policy is promoted because arbitration provides for a faster and less expensive resolution of disputes as compared to traditional litigation. Further, because arbitration diverts conflicts from the courts to the arbitral panels, it lightens the courts’ docket loads.
Section 2 of the Federal Arbitration Act provides:
A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof, or an agreement in writing to submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract. 
In other words, when parties agree to the inclusion of arbitration clauses in their contracts, courts generally deem the arbitration clauses enforceable, and the parties cannot have their disputes heard in court.
II. Discretionary Authority Granted to Bankruptcy Judges
The United States Code contains two sections that refer to the discretionary powers afforded bankruptcy judges. The first arises under the Bankruptcy Code. Section 305 of the Bankruptcy Code, 11 U.S.C. Section 305, provides in pertinent part:
(a) The court, after notice and a hearing…may suspend all proceedings
in a case under this title, at any time if-
(1) the interests of creditors and the debtor would be better served by
(2)(A) there is pending a foreign proceeding; and
(B) the factors specified in section 304(c) of this title warrant such’suspension.
The second section is found in 28 U.S.C. Section 157, relating to the Bankruptcy Court’s jurisdictional limits, which states:
(b)(1) Bankruptcy judges may hear and determine all cases under title 11 and all core proceedings arising under title 11 , or arising in a case under title 11, referred under subsection (a) of this section, and may enter appropriate orders and judgments….
(c)(1) A bankruptcy judge may hear a proceeding that is not a core proceeding but that is otherwise related to a case under title 11.
Congress’s use of the word “may” in both of the aforementioned sections demonstrates legislative intent to grant to the Bankruptcy Court wide discretion in contemplating when to abstain from hearing a particular dispute arising in a bankruptcy proceeding.
III. Enforceability of Arbitration and Mediation Clauses in Light of the Bankruptcy Code
Tension exists between public policy favoring the enforcement of contractual ADR provisions and the wide discretion afforded Bankruptcy Courts to hear disputes before them. What should occur if a dispute that would otherwise be governed by an ADR provision arises during the pendency of a bankruptcy case? Who should hear the dispute – the Bankruptcy Court or an arbitrator?
Notwithstanding the pronounced policy in favor of enforcing ADR provisions, Bankruptcy Courts demonstrate a reluctance to send disputes to ADR more frequently than other Federal and State courts. In considering the merits of arbitration in light of the specialization of the practice of bankruptcy law, the Third Circuit held in Zimmerman v. Continental Airlines, Inc. that:
Bankruptcy proceedings?have long held a special place in the federal judicial system. Because of their importance to the smooth functioning of the nation’s commercial activities, they are one of the few areas where Congress has expressly preempted state jurisdiction. While the sanctity of arbitration is a fundamental concern, it cannot be said to occupy a position of similar importance. Therefore, because of the importance of bankruptcy proceedings in general, and the need for expeditious resolution of bankruptcy matters in particular, we hold that the intentions of Congress will be better realized if the Bankruptcy Reform Act is read to impliedly modify the Arbitration Act.
Both the Zimmerman holding that provisions of Titles 11 and 28 modify the Arbitration Act under the Bankruptcy Reform Act, and the Bankruptcy Code’s wide grant of discretion to bankruptcy judges, have established a degree of discretion for bankruptcy judges to determine whether they must stay bankruptcy proceedings pending an ADR proceeding. Courts have held that the issue should be determined by whether the dispute falls within the Bankruptcy Court’s “core” or “non-core” jurisdiction, with the former type of disputes adjudicated by the Bankruptcy Court, and the latter referred to ADR.
Core disputes are those that arise under the provisions of the Bankruptcy Code or that arise in a case under the Code. Courts have held that a determination as to whether a dispute is core is dependent upon (1) whether the contract preceded the petition for reorganization, and (2) how dependent upon the reorganization proceedings the dispute is. Examples of core proceedings are delineated in 28 U.S.C. Section 157. Non-core disputes are those in which the Bankruptcy Court may have jurisdiction to preside, but relate to common or state law claims, or other claims that do not arise under bankruptcy law but may nonetheless relate to a bankruptcy case. Such disputes are considered not to arise under the Bankruptcy Code. The Bankruptcy Court may not enter final judgment on non-core matters without the full consent of all parties to the proceeding, but can only issue proposed findings of fact and legal conclusions for confirmation by the United States District Court. Moreover, if a party appeals a non-core ruling, the District Court reviews both the Bankruptcy Court’s findings of fact and law under the de novo standard.
Many courts which have reviewed the issue have held that the decision of where the resolution of core disputes should occur belongs within the discretion of bankruptcy judges. Thus, regardless of the existence of an otherwise valid contractual ADR clause, a Bankruptcy Court’s decision to hear a core proceeding in lieu of an arbitrator is given great deference.
However, the Bankruptcy Courts view the exercise of jurisdiction of non-core disputes in the face of ADR provisions differently. Jurisdiction over the non-core disputes in Bankruptcy Court is not mandatory, and the disputes may be resolved in other forums such as ADR. Thus, in cases of non-core disputes, courts have held that Bankruptcy Courts must abstain from hearing the disputes, and send the claims to ADR as dictated by the parties’ contract.
A minority of Federal courts have held that the core/non-core distinction is not solely determinative of whether the Bankruptcy Court must enforce a contractual arbitration or mediation clause. Instead, these courts also consider the following factors:
A. Whether the issue can be resolved more expeditiously by the bankruptcy judge as opposed to through the arbitration process;
B. Whether or not special expertise is necessary in deciding the issue;
C. The impact on creditors of the debtor who were never parties to the agreement containing the arbitration clause; and
D. Whether arbitration threatens the assets of the estate. 
The tension between the Federal Arbitration Act and sections 305 of the Bankruptcy Code and 157 of title 28 gives bankruptcy judges the discretion to retain jurisdiction of at least core disputes, despite contractual ADR provisions. That discretion is limited in non-core disputes in light of public policy of upholding arbitration clauses in contracts. Notwithstanding the widespread use and enforcement of ADR provisions in commercial settings, those clauses will only be given effect in the bankruptcy cases if the dispute is a non-core proceeding, or, in the case of core proceedings, if the bankruptcy judge decides to abstain from hearing the matter.
Arbitration clauses direct resolution of either specified claims or all disputes arising between the parties to an arbitral forum rather than the traditional courtroom.
See Dunes Hotel Assoc. v. Hyatt Corp. (In re Dunes Hotel Assoc.), 194 B.R. 967, 992 (D.S.C. 1995); Circle S. Enterprises, Inc. v. Stanley Smith & Sons, 343 S.E.2d 45, 46 (S.C. Ct. App. 1986); Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1 (1983).
9 U.S.C. Section 2 (2002).
11 U.S.C. Section 305 (2002) (emphasis added).
28 U.S.C. Section 157 (2002) (emphasis added).
712 F.2d 55, 59 (3rd Cir. 1983).
U.S. Brass Corp. v. Travelers Ins. Group, Inc. (In re U.S. Brass Corp.), 301 F.3d 296, 305 (5th Cir. 2002).
In re U.S. Lines, Inc., 197 F.3d at 637; N. Pipeline Const. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982).
Section 157 provides in pertinent part:
- (2) Core proceedings include, but are not limited to –
- (A) matters concerning the administration of the estate;
(B) allowance or disallowance of claims against the estate or exemptions from property of the estate, and estimation of claims or interests for the purposes of confirming a plan under chapter 11, 12, or 13 or title 11 but not the liquidation or estimation of contingent or unliquidated personal injury tort or wrongful death claims against the estate for purposes of distribution in a case under title 11;
(C) counterclaims by the estate against persons filing claims against the estate;
(D) orders in respect to obtaining credit;
(E) orders to turn over property of the estate;
(F) proceedings to determine, avoid, or recover preferences;
(G) motions to terminate, annul, or modify the automatic stay;
(H) proceedings to determine, avoid, or recover fraudulent conveyances;
(I) determinations as to the dischargeability of particular debts;
(J) objections to discharges;
(K) determinations of the validity, extent, or priority of liens;
(L) confirmations of plans;
(M) orders approving the use or lease of property, including the use of cash collateral;
(N) orders approving the sale of property other than property resulting from claims brought by the estate against persons who have not filed claims against the estate; and
(O) other proceedings affecting the liquidation of the assets of the estate or the adjustment of the debtor-creditor or the equity security holder relationship, except personal injury tort or wrongful death claims.
28 U.S.C. Section 157(b)(2).
Moore v. Jogert, Inc. (In re Jogert, Inc.), 950 F.2d 1498, 1501 (9th Cir. 1991) (quoting Taxel v. Electronic Sports Research (In re Cinematronics), 916 F.2d 1444, 1449 (9th Cir. 1990)). Non-core proceedings those causes of action that are not delineated in section 157(b)(2), existed prior to the petition date, exist independently of the title 11 petition, and where the rights and obligations of the parties remain virtually unaffected by the filing of the bankruptcy petition. Hughes-Bechtol, Inc. v. Constr. Mgmt., Inc. (In re Hughes-Bechtol, Inc.), 132 B.R. 339, 344 (Bankr. S.D. Ohio 1991) (quoting Hughes-Bechtol, Inc. v. Air Enter., Inc. (In re Hughes-Bechtol, Inc.), 107 B.R. 552, 556 (Bankr. S.D. Ohio 1989)).
Moore, 950 F.2d at 1501. When a court reviews a lower court’s decision under the de novo standard, the reviewing court regards the contents of the case before it as if the matter had originated in that court. In other words, the reviewing court does not give the lower court’s findings any deference.
See Ins. Co . of N. Am. v. NGC Settlement Trust & Asbestos Claims Mgmt. Corp. (In re Nat’l Gypsum Co.), 118 F.3d 1056, 1067 (5th Cir. 1997) (holding that “nonenforcement of an otherwise applicable arbitration provision turns on the underlying nature of the proceeding, i.e., whether the proceeding derives exclusively from the provisions of the Bankruptcy Code and, if so, whether arbitration of the proceeding would conflict with the purposes of the Code”). See also In re Gandy, 299 F.3d 489, 495 (5th Cir. 2002); U.S. Lines, Inc. v. Am. S.S. Owners Mut. Prot. and Indem. Assoc. (In re U.S. Lines Inc.), 197 F.3d 631, 640 (2nd Cir. 1999); Dunes Hotel Assoc., 194 B.R. at 993; Chas P. Young Co., 111 B.R. at 417.
Crysen/Montenay Engery Co. v. Shell Oil Co. and Scallop Petroleum Co. (In re Crysen/Montenay Energy Co.), 226 F.3d 160, 166 (2nd Cir. 2000). See also In re U.S. Lines, Inc., 197 F.3d 631 (2nd Cir. 1999); Nat’l Gypsum Co., 118 F.3d at 1066; Hays and Co. v. Merrill Lynch, Inc., 885 F.2d 1149 (3rd Cir. 1989).
Moore v. Green Tree Fin. Corp. (In re Moore), 1998 WL 2017186, at *5 (Bankr. D.S.C. 1998); Dunes Hotel Assoc., 194 B.R. at 993; In re Lawrence W. Thompson, No. 89-2767-18, slip op. at 2 (Bankr. D.S.C. Feb. 28, 1991).
Zimmerman, 712 F.2d at 59.