Second Circuit Rejects Arbitration of Debtor's Asserted Discharge Violation

The issues in Anderson turned on whether the debtor's discharge violation claim against the bank was subject to arbitration and whether that claim presented “the sort of inherent conflict with the Bankruptcy Code that would overcome the strong congressional preference for arbitration.” Anderson, at 6. The Second Circuit had previously recognized that arbitration can conflict with the bankruptcy policy of centralized dispute resolution. “Disputes that involve both the Bankruptcy Code and the Arbitration Act often present conflicts of 'near polar extremes: bankruptcy policy exerts an inexorable pull towards centralization while arbitration policy advocates a decentralized approach toward dispute resolution.'” Hill, 436 F.3d at 108, quoting U.S. Lines, 197 F.3d at 640. But the purposes of the Code are “seriously jeopardized” only when arbitration would interfere with the bankruptcy court's ability “to centralize disputes concerning the estate.” Id. at 109.

Facts

The debtor, Anderson, opened a credit card account in 2002 with the bank. The account agreement mandated arbitration of any controversy or dispute. Also, the arbitrator hearing the case had to be an experienced lawyer or a “former judge who must apply applicable substantive law,” and could award damages or other relief.

Anderson failed to repay the bank on his account for more than 180 days. The bank was therefore required to “charge off” the account — i.e., reclassify the account from a receivable to a loss. Consistent with federal regulatory guidelines, the bank noted the charge-off to the national credit reporting agencies and later sold the Anderson account to a third-party debt buyer. The bank also reported to the credit reporting agencies that it had sold Anderson's charged-off debt to another lender.

Anderson filed a Chapter 7 bankruptcy petition two years later in the Southern District of New York, and shortly after, obtained a standard form discharge order. He told the bank of his bankruptcy discharge, asking it to direct the credit reporting agencies to remove from his credit report any notation that it had charged off his loan. Because its charge-off was accurate, the bank declined. Federal regulators do not expect a bank to update an account after selling it to a third party, but instead, it need only state that it sold the account.

Anderson obtained the re-opening of his bankruptcy case several months later for the purpose of suing the bank on behalf of himself and a putative class. According to Anderson, by failing to furnish updates to the credit reporting agencies reflecting post-sale bankruptcy discharges, the bank intended to coerce payment on a discharged debt in violation of the bankruptcy court's discharge injunction.

The bank moved to compel arbitration of Anderson's claim. The bankruptcy court denied the motion, reasoning among other things, that because the debtor's “fresh start” was implicated, Congress intended to preclude arbitration, and that the arbitrator would probably be unable to grant injunctive relief. The district court affirmed for the same reasons, but added that the debtor's claims arose from a discharge injunction, an affirmative order of the bankruptcy court, finding that arbitration would interfere with the bankruptcy court's authority to enforce its own orders.

The Second Circuit

The Second Circuit also affirmed, stressing that “the discharge is the foundation upon which all other portions of the … Code are built.” Id. at 14. “The 'fresh start' is only possible if the discharge injunction . . . is fully heeded by creditors and prevents their further collection efforts. Violations of the injunction damage the foundation on which the debtor's fresh start is built.” Id. Citing United States Lines and Hill, the court found “that arbitration of a claim based on an alleged violation of [Code] Section 524(a)(2) would seriously jeopardize a particular core bankruptcy proceeding.'” Id. at 14-*15. A discharge violation claim thus requires continuing court “supervision … to enforce its own injunctions ….” Id. at 15.

First, reasoned the court, the primary importance of a debtor's bankruptcy discharge makes “arbitration of Anderson's claim …. an inherent conflict with the … Code.” Id. at 15. Second, “Anderson's [discharge violation] claims [were] still eligible for active enforcement.” Id. at 16. To distinguish its earlier decision in Hill, the court said “the discharge injunction is likely to be central to bankruptcy long after the close of proceedings,” in contrast to the automatic stay violation in Hill. The automatic stay “exists only while bankruptcy proceedings continue to ensure the status quo ante,” but “the integrity of the discharge must be protected indefinitely.” Id. at 16. Finally, a discharge injunction requires the court's “unique expertise … in interpreting its own injunctions and determining when they have been violated.” Id. at 17. Because the bankruptcy court, in the Second Circuit's view, considered “the conflicting policies,” it had “properly” exercised its discretion. Id.

Comments

The Second Circuit in Anderson failed to cite a significant contrary district court decision. Belton v. GE Capital Consumer Lending Bank, 2015 WL 6163083, 6-8 (S.D.N.Y. Oct. 15, 2015) (Congress never “intended to preclude arbitration of [§]524 claims”; Congress gave federal district courts non-exclusive jurisdiction over §524 claims; no “inherent conflict” between arbitrating such claims and underlying purpose of Bankruptcy Code; debtor's rights could be vindicated in arbitration; discharge injunction a “national form”; nothing suggested that “bankruptcy court … more qualified than an arbitrator to adjudicate [§524] claim[s].”). Belton is currently on appeal to the Second Circuit.

The Second Circuit's reasoning in Anderson is superficial, at best. Nothing in the text or legislative history of the Code suggests that Congress intended bankruptcy courts to have exclusive jurisdiction over discharge violation claims. In fact, Congress enacted the Arbitration Act “to reverse centuries of judicial hostility to arbitration agreements.” Shearson/Am. Express Inc. v. McMahon, 482 U.S. 220, 225-226 (1987). The Second Circuit conceded in Hill that when “arbitration would not interfere with or affect the distribution of the estate” or “affect an ongoing reorganization,” a bankruptcy court lacks discretion to deny arbitration. 463 F.3d at 109-110, citing Bigelow v. Green Tree Financial Servicing Corp., 2000 WL 3359 6476, 6 (E.D. Cal. Nov. 3, 2000) (compelled arbitration of §524 claim). The Anderson case, of course, was closed and the debtor had his discharge — i.e., no effect on reorganization or distributions to creditors.

Most important, Congress provided exclusive federal-court jurisdiction over specific bankruptcy-related claims (e.g., §327), but not §524 claims. See, 28 U.S.C. §§1334 (a) & (e). Congress gave bankruptcy courts non-exclusive jurisdiction over §524 claims. See, 28 U.S.C. §1334(b) (“… original but not exclusive jurisdiction ….”). Resolution of a discharge violation claim hardly requires unique bankruptcy expertise, for the issue is on whether the alleged act merely sought “to collect” a discharged debt. In Anderson, the arbitrator would be a lawyer or former judge.

Courts should “rigorously enforce” arbitration agreements according to their terms, consistent with the intent of Congress when it enacted the Arbitration Act. See, Italian Colors, 133 S. Ct. at 2309-10. This duty to enforce arbitration agreements “holds true for claims that allege a violation of a federal statute.” Id.; Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20 at 24-25 (1991) (“[S]tatutory claims may be the subject of an arbitration agreement….”); McMahon, 482 U.S. at 226 (same). Thus, courts must enforce arbitration agreements “unless Congress itself has evinced an intention to preclude a waiver of judicial remedies for the statutory rights at issue.” Mitsubishi Motors, 473 U.S. at 628. (Emphasis added).

The Supreme Court has consistently rejected arguments that federal statutory claims are not arbitrable. See, Mitsubishi Motors, 473 U.S. at 634, 637 (1985) (enforced agreement to arbitrate claims brought under Sherman Anti-Trust Act; no evidence in text or legislative history of anti-trust laws evincing congressional intent to preclude arbitration of anti-trust claims; no reason to “assume” that arbitration would not “provide an adequate mechanism” for enforcing anti-trust laws; “we decline to indulge the presumption that the parties and arbitral body conducting a proceeding will be unable or unwilling to retain competent, conscientious and impartial arbitrators.”); Gilmer, 500 U.S. at 24-25, 27-30 (enforced agreement to arbitrate claims brought under Age Discrimination Employment Act (ADEA); “Congress … did not explicitly preclude arbitration or other nonjudicial resolution of claims, even in its recent amendments”; “arbitration is consistent with Congress' grant of concurrent jurisdiction over ADEA claims to state and federal courts”; although ADEA designed to “further important social policies,” no “inherent inconsistency between those policies … and enforcing agreements to arbitrate age discrimination claims”; rejected unsubstantiated “challenges to the adequacy of arbitration procedures” — including competency of arbitrators and availability of equitable relief in arbitration; “[s]uch generalized attacks on arbitration 'res[t] on suspicion of arbitration as a method of weakening the protections afforded in the substantive law to would-be complainants,' and, as such, they are 'far out of step with our current strong endorsement of the federal statutes favoring this method of resolving disputes.'”); Greentree Fin'l Corp – Alabama v. Randolph, 531 U.S. 79, 90-91 (2000) (claims under Truth in Lending Act and Equal Credit Opportunity Act held arbitrable); Compu Credit Corp. v. Greenwood, 132 S. Ct. 665, 672 (2012) (claims under Credit Repair Organizations Act held arbitrable; neither text nor legislative history showed intent to override Arbitration Act).

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Michael L. Cook is of counsel, at Schulte Roth & Zabel LLP in New York and a member of this newsletter's Board of Editors.