Rudolph J. Di Massa Jr.

Drew S. McGehrin

In Anderson v. Credit One Bank, Case No. 16-2496 (2d Cir., March 7), the U.S. Court of Appeals for the Second Circuit affirmed decisions of both the District and Bankruptcy Courts for the Southern District of New York in addressing the enforceability of arbitration clauses in bankruptcy proceedings. The Court of Appeals ruled that the arbitration of a debtor’s cause of action alleging a creditor’s violation of the discharge injunction was in conflict with one of the crucial pillars of the Bankruptcy Code. That ruling notwithstanding, the court’s approach signaled at least a potential that it might take a more deferential stance in favor of arbitration under certain factual scenarios.

Facts

Orrin Anderson, the debtor in this case, held a credit card with Credit One Bank. The cardholder agreement underlying the credit card provided for an arbitration clause, allowing “either Anderson or Credit One to, without the other’s consent, require that any controversy or dispute … be submitted to mandatory, binding arbitration.”

In September 2011, Anderson defaulted on his credit card account. In March 2012, Credit One charged off Anderson’s debt and sold it to a third-party collections agent. Credit One reported the charge-off and sale of the debt to the three major consumer credit reporting agencies. In the wake of continued financial troubles, Anderson filed for protection under Chapter 7 of the Bankruptcy Code in January 2014. In May 2014, the U.S. Bankruptcy Court for the Southern District of New York entered an order of discharge releasing Anderson of his debts. The court then closed Anderson’s case.

In September 2014, Anderson contacted Credit One to request that the reported charge-off of his debt be removed from his credit report in light of the discharge he had received. When Credit One refused to do so, Anderson moved the bankruptcy court to reopen his case in order to pursue Credit One’s alleged violation of Anderson’s discharge injunction. The bankruptcy court granted Anderson’s motion, and Anderson accordingly filed a complaint against Credit One for “knowingly and willfully failing to update the credit reports” in what he described as an effort to coerce payment on the discharged debt in violation of the Bankruptcy Code Section 524 discharge injunction.

Credit One moved to compel arbitration of this claim pursuant to the terms of the cardholder agreement and for a stay of the bankruptcy proceeding. The bankruptcy court denied Credit One’s motion and, on appeal, the District Court for the Southern District of New York affirmed that denial.

Opinion of the Court of Appeals

The Second Circuit Court was tasked with deciding whether Congress intended the determination of an alleged violation of the discharge injunction to be nonarbitrable such that the bankruptcy court could exercise its discretion to refuse to compel arbitration. In order to do so, the appellate court needed to determine whether there existed an inherent conflict between arbitration clauses and the Bankruptcy Code. In making such a determination, the court emphasized the need for a “particularized inquiry” into the nature of the claim and circumstances surrounding the bankruptcy, as well as into the objectives of the Bankruptcy Code itself. Such relevant objectives included: the goal of a centralized resolution of “pure” bankruptcy issues; the need to protect creditors and reorganizing debtors from piecemeal litigation; and the undisputed power of a bankruptcy court to enforce its own orders.

In its analysis, the appellate court emphasized the “well-established” principle that the discharge—and the “fresh start” accompanying that discharge—form the foundation upon which all other sections of the Bankruptcy Code are built. Such a “fresh start” could only be possible, according to the appellate court, if the discharge injunction crafted by Congress and ordered by the bankruptcy court were fully heeded by creditors, and effectively prevented subsequent collections efforts.

Emphasizing the vital nature of the discharge in a bankruptcy case as the springboard for its opinion, the circuit court found that “arbitration of a claim based on an alleged violation [of the discharge injunction] would seriously jeopardize a … bankruptcy proceeding,” and affirmed the order of the district court. The court grounded its finding on three premises: the discharge injunction is vital to a bankruptcy court’s ability to provide debtors with a “fresh start,” a fundamental purpose of the Bankruptcy Code; the claim in this case pertained to an ongoing bankruptcy matter that required continued bankruptcy court supervision; and the equitable power of the bankruptcy court to enforce its own injunctions is central to the structure of the Bankruptcy Code.

First, and once again emphasizing the integral nature of a debtor’s discharge, the appellate court found that “because there is no matter more ‘central to the purposes and policies of the Bankruptcy Code,’ than the fresh start provided by discharge, arbitration of Anderson’s claim presents an inherent conflict with the Bankruptcy Code.” The arbitration of such central claims, therefore, would not comport with certain core purposes underlying the Bankruptcy Code.

Second, the appellate court noted that the alleged violation of the discharge injunction in this case was subject to active enforcement by the bankruptcy court: the nature of the discharge injunction and core purpose of the Bankruptcy Code require that the injunction be protected indefinitely; additionally, enforcement of an arbitration clause to litigate this point would run counter to crucial underpinnings of the code itself. Such an alleged violation stood in contrast to other bankruptcy-related issues that had, in the past, been found to be arbitrable, such as an alleged post-discharge violation of the automatic stay: “unlike the automatic stay, the discharge injunction is likely to be central to bankruptcy long after the close of proceedings” such that “the integrity of the discharge must be protected indefinitely.”

Finally, the appellate court examined the bankruptcy court’s power to enforce such orders in light of the proposed arbitration. As the appellate court noted, the “enforcement of injunctions is a crucial pillar of the powers of the bankruptcy courts and central to the statutory scheme.” Bankruptcy courts, in this context, possess a unique expertise in interpreting the very injunction they put into place, and are better equipped to determine whether the injunction has been violated. The court noted that Congress provided bankruptcy courts “wide latitude” to enforce their own orders, including the very discharge injunction at issue here. Emphasizing the need to respect the judicial process of instating and enforcing these injunctions, the circuit court determined that the “bankruptcy court alone has the power to enforce the discharge injunction” and that “arbitration of the claim would thus present an inherent conflict with the Bankruptcy Code.”

Thus, for the foregoing, reasons, the U.S. Court of Appeals for the Second Circuit held that there exists an inherent conflict between arbitration of an alleged violation of the discharge injunction of Bankruptcy Code Section 524 and the Bankruptcy Code itself. Accordingly, the appellate court affirmed the decisions of the bankruptcy and district courts.

Conclusion

In Anderson v. Credit One Bank, the Second Circuit issued an opinion that, on its face, falls in line with the traditional resistance to arbitration clauses that bankruptcy courts have consistently demonstrated. According to this traditional school of thought, compelling arbitration of these matters would inject uncertainty into outcomes, precipitate potential adverse consequences to other creditors, and likely deplete the estate of funds that may otherwise be available for distribution to creditors. What is notable, however, is the court’s “particularized approach” to this issue: delineating and thoroughly examining every justification for the refusal to enforce arbitration provisions, all in acknowledgement of the “federal policy favoring arbitration” extant in the Federal Arbitration Act. In the end, this “particularized” and methodical approach may signal the circuit court’s intention to make greater use of arbitration within certain facets of a bankruptcy case.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.

Drew S. McGehrin, an associate at the firm, practices in the areas of commercial finance, financial restructuring and bankruptcy. 

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.