Releasing the Albatross

There is strong federal policy in favor of permitting parties to resolve disputes through arbitration. National Broadcasting Co., Inc. v. Bear Stearns & Co., 165 F.3d 184, 190 (2d Cir. 1999) (there is “strong federal policy favoring arbitration as an alternative means of dispute resolution.”). “The advantages of arbitration are many: it is usually cheaper and faster than litigation; it can have simpler procedural and evidentiary rules …” Allied-Bruce Terminix Co., Inc. v. Dobson, 513 U.S.265, 280 (1995) (quoting H.R. Rep. No. 97-542, p. 13 (1982)). As the Supreme Court noted, the federal arbitration statute “was designed to allow parties to avoid 'the costliness and delays of litigation … '” Scherk v. Alberto-Culver Co., 417 U.S. 506, 510-11 (1974) (quoting H.R. Rep. No. 96, 68th Cong., 1st Sess., 1, 2 (1924)).

Consistent with this policy goal, bankruptcy courts have approved ADR procedures for the resolution of disputed claims that stay related actions pending the parties' participation in an ADR process. See, e.g., In re Lodgian, Inc., No. 01-16345 (BRL) (Bankr. S.D.N.Y. Dec. 6, 2002) (order staying state court actions and approving alternative dispute resolution program); In re Bradlees Stores, Inc., Nos. 00-16033, 00-16035, 00-16036 (BRL) (Bankr. S.D.N.Y. Sept. 5, 2001) (same); In re Caldor, Inc., No. 95-44080 (JLG) (Bankr. S.D.N.Y. 1999) (order approving alternative dispute resolution program). The establishment of these types of procedures allow the bankruptcy court to resolve tort claims consistent with 28 U.S.C. ' 157(b)(2)(B), which provides, inter alia, that the bankruptcy court may not liquidate “personal injury tort and wrongful death claims”. [Under 28 U.S.C. 157(b)(5), these claims are to be tried "in the district court in which the bankruptcy case is pending, or in the district court in this district in which the claim arose ... " 28 U.S.C. ' 157(b)(5)]. Since the ADR procedures are non-binding (unless the parties elect otherwise), they do not constitute the “liquidation” of the tort claims; however ADR still provides for the potential resolution of such claims without the necessity for individual trials in multiple forums.

ADR Procedures

ADR procedures have many different forms. For example, the procedures approved in both Lodgian and Bradlees each contemplated a three-step process. The initial phase was pre-arbitration settlement, during which the parties exchanged information and attempted to settle the claims. If the claims were not settled, the parties then proceeded to non-binding mediation. If mediation failed, the arbitration phase commenced during which the parties took expedited discovery and then proceeded to arbitration. Thereafter, a party dissatisfied with the results of the arbitration could file a notice of intent to litigate and proceed to liquidate the claim in the bankruptcy or district court, as applicable under 28 U.S.C. ' 157, or seek relief from the stay imposed by the ADR procedures to proceed in state court (Upon mutual consent by the debtors and the claimant, the arbitration would be binding. Decisions rendered in binding arbitration were only appealable on the basis of corruption, mistake or the like under Sections 10 and 11 of the Federal Arbitration Act, rather than on the merits of the claim.). The procedures were coupled with a grant of authority pursuant to Bankruptcy Rule 9019(b), authorizing the settlement of claims without further hearing or motion, so that agreements reached during the process were self-effectuating.

A critical provision of these ADR procedures was that state court actions were stayed by the order approving the ADR procedure or by operation of law (ie, by the automatic stay under section 362 of the Bankruptcy Code and/or the discharge injunction under section 524 of the Bankruptcy Code), mandating the claimants' participation in the process. If some claimants were allowed to circumvent the process by proceeding to litigate their claims, other similarly situated claimants would cry unfairness. Moreover, such circumvention would undermine the purposes of the ADR procedure, which is to enable the debtors to promptly make settlement offers, facilitate the exchange of information and resolve disputed tort claims in an efficient, streamlined manner, without the costs associated with litigating each claim. The authority of the bankruptcy court to enjoin a state court action emanates from section 105 of the Bankruptcy Code, together with the automatic stay of section 362 and/or the discharge injunction of section 524. (Section 105 provides the bankruptcy courts with the power to issue “any order … necessary or appropriate” to carry out the provisions of the Bankruptcy Code. Section 362 provides for, inter alia, an automatic stay of actions against the debtor arising from prepetition claims that lasts from the filing of a Chapter 11 case until confirmation, while section 524(a) provides that a discharge in bankruptcy serves as an injunction against such actions after confirmation. But until the Federated decision, there has been little attention given to constitutional authority of the bankruptcy court to issue such injunctions of state court proceedings.

Conclusion

Next month's article discusses The Sixth Circuit's Decision in Federated, and its resultant changes to the bankruptcy community.

In the context of large Chapter 11 cases, the resolution of disputed claims can often be the proverbial albatross around the neck of the debtor, delaying the closing of the debtor's case to the detriment of the debtor's estate. The litigation costs associated with the resolution of hundreds or thousands of disputed claims operate as a drain on estate assets, thereby reducing the value of the estate and ultimately lowering values received by creditors holding allowed claims. Chapter 11 cases can last for months or years after plan confirmation solely as a result of unresolved disputed claims. Swift claims resolution can be especially problematic when dealing with tort or other claims where factual issues predominate.

To address the speedy resolution of such claims, debtors have increasingly turned to mandatory “alternative dispute resolution” or “ADR” procedures. Generally, such ADR procedures stay related non-bankruptcy court actions and require claimants to engage in mediation and/or non-binding arbitration with the debtors prior to seeking relief from the bankruptcy court to allow them to proceed with their case in a non-bankruptcy forum. It is clear that the bankruptcy court may institute voluntary ADR programs in lieu of state court actions, ie, where the affected creditors elect to participate. See Federal Rule of Bankruptcy Procedure 9019(c), which states that “On stipulation of the parties to any controversy affecting the estate the court may authorize the matter to be submitted to final and binding arbitration.” But there has been little consideration of the bankruptcy court's ability to require claimants to participate in mandatory ADR procedures. Recently, in Spierer v. Federated Department Stores, et al. (In re Federated Department Stores), 328 F. 3d 829 (6th Cir. 2003) (hereinafter, “Federated“), the Sixth Circuit affirmed the power of the bankruptcy courts to implement mandatory ADR procedures. Of importance, the Federated court confirmed that the constitutional authority of the bankruptcy court to oversee the expeditious resolution of claims includes utilization of a mandatory ADR procedure.

The Utilization of Mandatory ADR by Bankruptcy Courts

There is strong federal policy in favor of permitting parties to resolve disputes through arbitration. National Broadcasting Co., Inc. v. Bear Stearns & Co. , 165 F.3d 184, 190 (2d Cir. 1999) (there is “strong federal policy favoring arbitration as an alternative means of dispute resolution.”). “The advantages of arbitration are many: it is usually cheaper and faster than litigation; it can have simpler procedural and evidentiary rules …” Allied-Bruce Terminix Co., Inc. v. Dobson, 513 U.S.265, 280 (1995) (quoting H.R. Rep. No. 97-542, p. 13 (1982)). As the Supreme Court noted, the federal arbitration statute “was designed to allow parties to avoid 'the costliness and delays of litigation … '” Scherk v. Alberto-Culver Co., 417 U.S. 506, 510-11 (1974) (quoting H.R. Rep. No. 96, 68th Cong., 1st Sess., 1, 2 (1924)).

Consistent with this policy goal, bankruptcy courts have approved ADR procedures for the resolution of disputed claims that stay related actions pending the parties' participation in an ADR process. See, e.g., In re Lodgian, Inc., No. 01-16345 (BRL) (Bankr. S.D.N.Y. Dec. 6, 2002) (order staying state court actions and approving alternative dispute resolution program); In re Bradlees Stores, Inc., Nos. 00-16033, 00-16035, 00-16036 (BRL) (Bankr. S.D.N.Y. Sept. 5, 2001) (same); In re Caldor, Inc., No. 95-44080 (JLG) (Bankr. S.D.N.Y. 1999) (order approving alternative dispute resolution program). The establishment of these types of procedures allow the bankruptcy court to resolve tort claims consistent with 28 U.S.C. ' 157(b)(2)(B), which provides, inter alia, that the bankruptcy court may not liquidate “personal injury tort and wrongful death claims”. [Under 28 U.S.C. 157(b)(5), these claims are to be tried "in the district court in which the bankruptcy case is pending, or in the district court in this district in which the claim arose ... " 28 U.S.C. ' 157(b)(5)]. Since the ADR procedures are non-binding (unless the parties elect otherwise), they do not constitute the “liquidation” of the tort claims; however ADR still provides for the potential resolution of such claims without the necessity for individual trials in multiple forums.

ADR Procedures

ADR procedures have many different forms. For example, the procedures approved in both Lodgian and Bradlees each contemplated a three-step process. The initial phase was pre-arbitration settlement, during which the parties exchanged information and attempted to settle the claims. If the claims were not settled, the parties then proceeded to non-binding mediation. If mediation failed, the arbitration phase commenced during which the parties took expedited discovery and then proceeded to arbitration. Thereafter, a party dissatisfied with the results of the arbitration could file a notice of intent to litigate and proceed to liquidate the claim in the bankruptcy or district court, as applicable under 28 U.S.C. ' 157, or seek relief from the stay imposed by the ADR procedures to proceed in state court (Upon mutual consent by the debtors and the claimant, the arbitration would be binding. Decisions rendered in binding arbitration were only appealable on the basis of corruption, mistake or the like under Sections 10 and 11 of the Federal Arbitration Act, rather than on the merits of the claim.). The procedures were coupled with a grant of authority pursuant to Bankruptcy Rule 9019(b), authorizing the settlement of claims without further hearing or motion, so that agreements reached during the process were self-effectuating.

A critical provision of these ADR procedures was that state court actions were stayed by the order approving the ADR procedure or by operation of law (ie, by the automatic stay under section 362 of the Bankruptcy Code and/or the discharge injunction under section 524 of the Bankruptcy Code), mandating the claimants' participation in the process. If some claimants were allowed to circumvent the process by proceeding to litigate their claims, other similarly situated claimants would cry unfairness. Moreover, such circumvention would undermine the purposes of the ADR procedure, which is to enable the debtors to promptly make settlement offers, facilitate the exchange of information and resolve disputed tort claims in an efficient, streamlined manner, without the costs associated with litigating each claim. The authority of the bankruptcy court to enjoin a state court action emanates from section 105 of the Bankruptcy Code, together with the automatic stay of section 362 and/or the discharge injunction of section 524. (Section 105 provides the bankruptcy courts with the power to issue “any order … necessary or appropriate” to carry out the provisions of the Bankruptcy Code. Section 362 provides for, inter alia, an automatic stay of actions against the debtor arising from prepetition claims that lasts from the filing of a Chapter 11 case until confirmation, while section 524(a) provides that a discharge in bankruptcy serves as an injunction against such actions after confirmation. But until the Federated decision, there has been little attention given to constitutional authority of the bankruptcy court to issue such injunctions of state court proceedings.

Conclusion

Next month's article discusses The Sixth Circuit's Decision in Federated, and its resultant changes to the bankruptcy community.