Bankruptcy Court Must Defer to Arbitration for Noncore Claims

Sarah Hautzinger

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff


            In In re McPherson, a Maryland bankruptcy court held that when a prepetition contract contains an arbitration clause, the bankruptcy court must defer to the arbitration as to the prepetition noncore claims.[1] John McDonnell McPherson (“Debtor”) entered into a Litigation Funding Agreement (“Funding Agreement”) with Camac Fund, L.P. (“Camac”),[2] pursuant to which Camac “extend[ed] financing to the Debtor in exchange for a percentage of the Debtor’s [recoveries from certain litigation].”[3] Eventually, the parties came to a dispute, and Camac invoked the arbitration clause in the Funding Agreement.[4] Thereafter, the Debtor filed a petition for relief under chapter 11 of title 11 of the United States Code (“Bankruptcy Code”), which automatically stayed all litigation against the Debtor, including the arbitration.[5] Camac filed a request to lift the automatic stay to allow the arbitration to proceed.[6] The Debtor opposed the request, arguing the dispute should be resolved in the bankruptcy court.[7]

         In this instance, the Maryland bankruptcy court concluded that a court must defer to the arbitration as to the noncore claims.[8] The constitutionally core claims that arose would remain subject to the automatic stay in connection with the chapter 11 case.[9] The court began by analyzing the tension between the Bankruptcy Code and the Federal Arbitration Act (“FAA”) in a chapter 11 case.[10] According to the court, the Bankruptcy Code provides a central “forum,” in the form of the bankruptcy court, to “consolidate[] the resolution” of the debtor’s matters.[11] Conversely, the FAA “creates a strong presumption in favor of arbitration” when an agreement contains an arbitration clause.[12] To determine if the claims should be arbitrated, the court noted that the Supreme Court previously stated in McMahon that “the FAA’s mandate may be overridden by a contrary congressional command.”[13] Therefore, a court must determine whether the claim is “constitutionally core” (i.e., “stems from the bankruptcy”) in determining whether the court should adjudicate the claim.[14]

            The Maryland bankruptcy court employed a four step “arbitrability analysis” to decide whether the claims were arbitrable.[15] The first two steps involved determining (i) whether the parties agreed to arbitrate, and (ii) the scope of the arbitration agreement.[16] The court found that the parties agreed to arbitrate and that the arbitration clause “does not by its plain language suggest a broad application.”[17] In the third step, the court split the parties’ claims into three categories (Bankruptcy Claims, FDCPA Claim, and Contract Claims) to consider whether Congress intended those claims to be non-arbitrable.[18] First, the court held that the Debtor’s Bankruptcy Claims arose under federal law and were constitutionally core claims because they stemmed from the bankruptcy.[19] Second, the court held that the Debtor’s FDCPA Claim was not constitutionally core because it sought to augment the Debtor’s estate as a vehicle for damages rather than a defense; therefore, it was subject to arbitration.[20] Third, the court held that the Contract Claims were “grounded in state law,” thus classifying them as non-core and subjecting them to arbitration.[21] In the fourth step, the court considered whether to stay the bankruptcy proceedings pending arbitration, simply because some of the claims were arbitrable, non-core claims.[22] The court explained that it was bound by the Fourth Circuit’s decision in Moses v. CashCall, Inc., which requires a bifurcation of constitutionally core and non-core claims.[23] Based on this bifurcation, the Contract Claims and FDCPA Claim would proceed under arbitration while the Bankruptcy Claims remained in bankruptcy court.[24]

            Here, according to the Maryland bankruptcy court, consolidation of the claims, not bifurcation, would have been the most “efficient and fair” resolution.[25] The dangers of bifurcation might include “overlap in facts, duplication in effort, and conflicting results.”[26] Indeed, the court noted that if it had been “writing on a clean slate,” it would have reached “a very different conclusion,” but it could not ignore binding precedent.[27] Accordingly, the court was bound to strike a balance between the Bankruptcy Code and the FAA.

[1] See In re McPherson, 630 B.R. 160, 165 (Bankr. D. Md. 2021).

[2] Id.

[3] Id.

[4] Id.

[5] Id.

[6] Id. (“The Stay Motion seeks relief from the automatic stay of . . . the [Bankruptcy] Code.”). Id. at 166. An automatic stay enjoys the proceedings against a debtor. Id. (A bankruptcy court shall grant relief from the automatic stay if “cause exists for that relief.”) Id.

[7] Id. at 166.

[8] Id. at 169.

[9] Id. at 179.

[10] Id. at 164.

[11] Id. (noting that the bankruptcy court “allow[s] a debtor to catch its financial breath and develop a cohesive reorganization plan; provide[s] consistency and certainty in the resolution of matters potentially affecting the debtor’s reorganization; and ensure[s] fair and equal treatment of the debtor’s creditors”).

[12] Id.

[13] Id. (citing Shearson/American Exp., Inc. v. McMahon, 482 U.S. 220, 226 (1983)).

[14] Id. at 168 (citing Allied Title Lending, LLC v. Taylor, 420 F. Supp. 3d 436, 448 (E.D. Va. 2019)).

[15] Id. at 170.

[16] Id.

[17] Id.

[18] Id. at 171–72.

[19] Id. at 173 (finding that the Debtor’s allegations challenge Camac’s ability to assert an allowed claim against the Debtor’s estate, and that the Debtor’s fraudulent transfer claim against Camac could not be brought absent the Code).

[20] Id. at 175–76 (noting that the FDCPA Claim was unlike the Bankruptcy Claims because of its non-defensive purpose).

[21] Id. at 176.

[22] Id. at 170.

[23] Id. at 176 (citing Moses v. CashCall, Inc., 761 F.3d 63, 71 (4th Cir. 2015)).

[24] Id. at 179.

[25] Id. at 177. The court also quoted Judge Niemyer’s dissent in CashCall, citing his explanation that “sending non-core claims to arbitration can, in given circumstances, interfere with the debtor’s chance to complete a fair and efficient . . . reorganization.” Id. at 176 (citing Moses v. CashCall, Inc., 781 F.3d 63, 73–74 (4th Cir. 2015) (Niemeyer, J., dissenting)).

[26] Id. at 177.

[27] Id.