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Supreme Court Decision Potentially Impacts Arbitrability of Bankruptcy Issues

February 12, 2019

U.S. Supreme Court Justice Brett Kavanaugh’s first opinion – Henry Schein Inc. v. Archer & White Sales Inc. – is of particular interest to creditors. In Henry Schein, the United States Supreme Court was asked to determine whether judges or arbitrators should consider whether a dispute is arbitrable. In the past, the Supreme Court has held that if an arbitration agreement includes “clear and unmistakable evidence” that the parties intended to have the question of arbitrability delegated to the arbitrator, then courts should refrain from considering if the matter can be arbitrated. Several Circuit Courts of Appeal have applied an exception to this rule – that is, if a claim that the dispute must be arbitrated is “wholly groundless,” a court does not need to bother sending the case to an arbitrator, since it will end up at the court anyway. In his opinion, Justice Kavanaugh rejected this exception, finding that “The [federal arbitration] act does not contain a ‘wholly groundless’ exception, and we are not at liberty to rewrite the statute passed by Congress and signed by the President,” he wrote. “When the parties’ contract delegates the arbitrability question to an arbitrator, the courts must respect the parties’ decision as embodied in the contract.”

While the eight-page opinion may seem unassuming, it causes significant uncertainty in the bankruptcy world. In several bankruptcy cases, some Circuit Courts of Appeal have rejected Justice Kavanaugh’s approach, reasoning that a court should have discretion to disregard an arbitration agreement if the proceeding is core and presents a “severe conflict” with the Bankruptcy Code. Take for example the common scenario of a debtor-individual and creditor-lender entering into a contract which states that the parties agree to arbitrate all disputes. The debtor then files for bankruptcy and receives a discharge.  After the discharge is granted, the debtor alleges that the creditor violated the discharge injunction guaranteed by Section 524 of the Bankruptcy Code. In response, the creditor moves to compel arbitration, citing the parties’ pre-bankruptcy agreement. In reply, the debtor takes the position that the agreement does not contemplate the dispute at hand and arbitration should not be allowed. The Second, Fourth, Fifth, and Ninth Circuit Courts of Appeal have all previously found that a bankruptcy judge has discretion to disregard an arbitration agreement if a debtor’s allegations raise a “core” bankruptcy claim. However, in light of the recent Henry Schein decision stating that courts should keep their hands out of determining arbitrability, it is uncertain whether proceedings in bankruptcy are an exception to this rule.

The Supreme Court’s decision has the potential to significantly impact the arbitrability of bankruptcy issues. Creditors should review their agreements to review the scope of arbitration clauses, and consider consulting with skilled legal counsel to examine how the Henry Schein case impacts any relief that can be sought.