Illinois Bankruptcy Court: Whether Dispute Is Core Or Non-Core Not "Bright Line" In Determining Enforceability Of Arbitration Clause

• Published date: 27 July 2023
• Subject Matter: Litigation, Mediation & Arbitration, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Arbitration & Dispute Resolution
• Law Firm: Jones Day
• Author: Mr Mark Douglas

Whether a dispute that is subject to arbitration can or must be referred to arbitration after one of the parties to a prepetition arbitration agreement files for bankruptcy has long been a source of disagreement among bankruptcy and appellate courts due to a perceived conflict between the Federal Arbitration Act and the Bankruptcy Code. The U.S. Bankruptcy Court for the Northern District of Illinois recently provided some useful guidance regarding this issue.

In Johnson v. S.A.I.L. LLC (In re Johnson), 649 B.R. 735 (Bankr. N.D. Ill. 2023), the court denied in part and granted in part a motion demanding that certain disputes between a chapter 13 debtor and her prepetition lender be referred to arbitration in accordance with the terms of an arbitration clause in a loan agreement. In so ruling, the court emphasized that, in determining whether a dispute should be arbitrated instead of adjudicated by a bankruptcy court, there is no "bright line" rule dependent on whether the dispute is within the court's "core" jurisdiction. Instead, the court must examine the nature of the dispute, including whether it is core or non-core, to determine whether arbitration would inherently conflict with the policies underlying the Bankruptcy Code. If such an inherent conflict exists, a demand to arbitrate the dispute should be denied.

Arbitration of Disputes in Bankruptcy

Whether a contractual arbitration clause will be enforced by the bankruptcy courts in accordance with the Federal Arbitration Act, 9 U.S.C. ' 1 et seq. (the "FAA"), has been the focus of debate in bankruptcy and appellate courts for decades. The FAA provides that, with certain exceptions, arbitration agreements "shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." FAA '  2. Pursuant to the FAA, arbitration agreements must generally be enforced in commercial disputes. See Dean Witter Reynolds, Inc. v. Byrd, 770 U.S. 213, 218 (1985) ("[I]nsofar as the language of the [FAA] guides our disposition of this case, we would conclude that agreements to arbitrate must be enforced, absent a ground for revocation of the contractual agreement.").

In Shearson/Am. Exp. Inc. v. McMahon, 482 U.S. 220, 226-27 (1987), the U.S. Supreme Court ruled that the FAA's mandate may be overridden if a party opposing arbitration can demonstrate that "Congress intended to preclude a waiver of judicial remedies for the statutory rights at issue." According to the Court, such congressional intent can be discerned in one of three ways: (i) the text of the statute; (ii) the statute's legislative history; or (iii) "an inherent conflict between arbitration and the statute's underlying purposes." The party opposing arbitration bears the burden of showing that "Congress intended to preclude a waiver of judicial remedies for the statutory rights at issue." Id. at 227; accord Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 26 (1991).

Guided by this mandate, in the past, the consensus among most courts addressing the issue has been that a bankruptcy court can adjudicate a dispute otherwise subject to binding arbitration if the dispute falls within the court's "core" jurisdiction, but in all other cases it must defer to arbitration. See generally Collier on Bankruptcy ("Collier") ' 9019.05[2] (16th ed. 2023).

However, the approach adopted by most circuit courts that have considered the issue is more nuanced. Rulings from the Second, Third, Fourth, Fifth, Ninth, and Eleventh Circuits...