Arbitration, Mediation, And Bankruptcy: What Are The Limits?

Overland Park Business Bankruptcy Attorney

Judges in general are believers in mediation.  It can be a highly effective way of identifying differences between litigants, crafting solutions to sticking points, and permitting litigants to vent their grievances.  Bankruptcy judges can and do order mediation in situations where contested matters are in need of a push forward.  But there are qualifications and limitations on arbitration, like anything else.

A recent Kansas bankruptcy case laid out some of these standards, and it is useful for us to discuss them.  These issues were discussed in a memorandum opinion written by Judge Somers in the case of In Re Brooke in 2013.  The opinion discusses who can compel arbitration, how a litigant can waive his ability to compel arbitration, and what things can be arbitrated in bankruptcy court.

The disputes in the Brooke case were complicated, of course, but essentially they involved problems that developed between the debtor Brooke, a corporation, and two of its franchised insurance agencies (Bucheli Insurance Agency and Hosford Insurance Agency).  Another entity named Fausto Bucheli was the principal equity holder of these agencies.  Bucheli and the two franchised agencies had filed claims in the Brooke Chapter 11 case, stating they were owed unpaid commissions and also seeking reimbursement for other monies spent.

They also claimed they were owed monies as a result of the debtor’s breach of contract.  The Brooke Chapter 11 case was later converted to a Chapter 7 case.  The Chapter 7 trustee filed adversary actions against the franchised insurance agencies (and an individual affiliated with the agencies) for recovery of fraudulent conveyances under section 11 U.S.C. 548(a)(1), 11 U.S.C. 550.  The Chapter 7 trustee also objected to the proofs of claim filed by the agencies.

But this was not all.  About two years after the adversary actions had been commenced by the Chapter 7 trustee, the defendant agencies asked the court to dismiss the complaints, arguing that the claims should first have gone to arbitration as stated in their old contract.  The original franchise agreement between Brooke and the agencies had a boilerplate arbitration provision in it.  These are often found in business contracts, and state that if the parties have a dispute, they must first seek to have their claims mediated or subjected to binding arbitration before taking further legal action.

Judge Somers’s opinion addressed many issues involving arbitration and bankrtupcy.  He analyzed the language of the original franchise agreements and found that simply having a guaranty’s signature there cannot compel the guaranty to participate in arbitration.  To enforce arbitration, a person should be an actual party to the original agreement.  A signature alone, without any additional language of incorporation, was not sufficient under Kansas law.  The individual guaranty (Bucheli), therefore, could not be compelled to arbitrate.

The second issue addressed by the Court was the idea that a party can actually waive its right to arbitrate if it sleeps on its rights for too long.  The doctrine of laches is alive and well.  The gist of the finding here was that, because the agencies had been participating in the adversary case for two years and never brought up arbitration before, they could not do so now in support of a motion to dismiss.

Commenting on an old proof of claim filed by the defendants at the outset of the case, the Court found that it made no attempt “to preserve the right to arbitrate.”  The fact that the defendants had been litigating the case for two years also did not sit well with the Court.  Under these circumstances, raising the arbitration issue looked like nothing more than a litigation tactic.

Furthermore, the matters at issue—fraudulent conveyances, transfers, etc.—were pure bankruptcy issues.  They were “core issues” arising out of the very act of filing the bankruptcy.  Arbitration was not the right forum for such contested matters.  Thus, even if the defendants had raised the arbitration issue in a timely fashion, it is unlikely that the bankruptcy court would have permitted arbitration.

Some things are the exclusive province of the bankruptcy court.  We can make some general conclusions from all this regarding arbitration, bankruptcy, and the interplay of one with the other:

  •  A bankruptcy court is not necessarily bound by arbitration language in a contract. Besides the usual issues of unfairness, adhesion terms, and disclosure, there are some issues that don’t belong in arbitration.  They are issues specifically arising out of bankruptcy law, and belong in front of the bankruptcy judge.
  • To be bound by an agreement, a person must have been a party to that agreement. This is the old contract principle of “privity” raising its head again.  Privity doctrine is alive and well.
  • Even if a contract provision (arbitration) is enforceable, that provision can be waived by the conduct of the party. Here, one of the litigants took no action to raise an issue for two years, and by its conduct waived the right to raise that issue.

All in all, the Brooke case has as much to say about contract law as it does about bankruptcy and arbitration.  If you a legal claim or defense, you need to raise it at the earliest possible opportunity.

Not doing so may eventually act as a constructive waiver of the issue.  In the Brooke case, however, it appears unlikely that the bankruptcy court would have been persuaded even if the defendants had raised the issue.  Why?  As noted above, the transfer issues and preference issues were core matters inherent to the bankruptcy case, and were not really appropriate for arbitration.

Read More:  Buying And Selling Bankruptcy Proofs Of Claim

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