Contributed by Joshua Nemser
There is no traffic light at the crossroads of arbitration and bankruptcy law. A litigant does not enjoy the certainty of an inevitable green light, allowing her to proceed in a direction of her choosing (arbitration or in-court resolution). Instead, a bankruptcy judge stands at the intersection, directing traffic on a case-by-case basis. Generally, bankruptcy courts will permit arbitration of non-bankruptcy issues. When an issue involves interpretation or application of bankruptcy law, the issue of arbitrability is less clear.
This summer, while many were enjoying outdoor barbecues and art parties at MoMa’s PS1, we blogged about a decision from the Bankruptcy Court for the Southern District of New York that denied arbitration on the grounds that a determination of property of the estate constitutes a core proceeding “arising in” the bankruptcy case. Earlier this month, we took a break from New Year’s Eve with Carson Daly to blog about a case out of the Bankruptcy Court for the District of New Jersey that permitted arbitration of stay violation claims. Today, we bring you another helpful decision brought to you by the Southern District of New York.
In the ordinary course of manufacturing Twinkies, Zingers, Chocodiles, Ding Dongs, Devil Dogs, Funny Bones, Ring Dings, Ho Hos, Sno Balls, Yodels, and Wonder Bread, Hostess Brands Inc. maintained workers’ compensation and other insurance policies with ACE American Insurance Company. In connection with these policies, Hostess and ACE executed a collateral agreement to secure Hostess’s current and future performance obligations. The collateral agreement included an arbitration provision.
In its chapter 11 case, Hostess sought to use ACE’s cash collateral to fund the insurance programs; use of the cash collateral, however, inevitably would reduce the amount of ACE’s security. ACE responded by filing a motion to compel arbitration of the issue of whether Hostess breached its collateral agreement with ACE by seeking non-consensual use of cash collateral. ACE argued that the dispute must be arbitrated pursuant to the arbitration clause in the agreement. The debtors, however, countered that the issue requiring resolution arose under section 363(c)(2) of the Bankruptcy Code, which permits use of an entity’s cash collateral regardless of contractual restrictions.
Judge Drain’s modified bench ruling denying ACE’s motion provides a useful analysis of the intersection of bankruptcy and arbitration in the Southern District of New York. The court discussed prior SDNY caselaw, noting that “substantially” core proceedings, or those that are “truly a function of the bankruptcy process,” are especially susceptible to the denial of arbitration. The court then found that resolution of the use of cash collateral is a “substantially core” issue “central to the bankruptcy process that Congress contemplated as substantially altering otherwise existing and enforceable rights under applicable non-bankruptcy law.” Acknowledging that the ACE arbitration provision was broad, the court found that “it does not deal with the unique bankruptcy context of the cash collateral motion.” Judge Drain acknowledged that Congress never provided that cash collateral issues were not arbitrable. On the other hand, it granted bankruptcy courts explicit statutory authority to make cash collateral decisions.
In supporting its decision, the court contrasted the arbitration process against the familiar bankruptcy practice of notice and hearing. Under arbitration, the proceeding would be reduced to a two party dispute determined with “regard to the custom and usage of the insurance business.” Alternatively, denial of arbitration would provide other interested parties with notice of the proceedings, and, more importantly, a right to intervene. It also would permit a bankruptcy judge to make the “final call” with respect to the bankruptcy-related decision.
This case reminds us that the bankruptcy process raises many unique issues. Alternative methods of dispute resolution may be generally favored, but they are not necessarily appropriate in the multi-party world of chapter 11. While there is no certainty as to the arbitration issue, evolving caselaw delineating those issues which are “substantially core” to the bankruptcy process will continue to provide clarification.