Arbitration Limitation: Ninth Circuit Holds That A Bankruptcy Court May Refuse To Enforce An Arbitration Clause

Clients often raise questions concerning the enforceability of arbitration clauses in bankruptcy proceedings. While this topic has been hotly debated for many years, a recent Ninth Circuit opinion, In re Thorpe Insulation Co., 671 F.3d 1011 (9th Cir. 2012), reminds us that arbitration clauses are not sacrosanct and can be struck down by the court.

For several decades, Thorpe distributed and installed asbestos-containing products. After many thousands of claims for asbestos-related injuries and deaths were brought against it, Thorpe entered into an agreement (the Agreement) with one of its insurers, Continental Insurance Company (Continental), relating to those claims. Thorpe and Continental agreed to arbitrate disputes regarding the Agreement. A few years later, daunted by the many claims against it, Thorpe filed for Chapter 11 bankruptcy, with the goal of confirming a plan of reorganization pursuant to section 524(g) of the Bankruptcy Code, which provides a unique mechanism for consolidating a debtor's asbestos-related assets and liabilities into a single trust for the benefit of present and future asbestos claimants. In preparation for the bankruptcy filing, some insurers of Thorpe agreed to assign certain rights against other insurers, including Continental, to Thorpe and the trust to be established under § 524(g), an assignment which Continental believed breached the Agreement. Continental filed a proof of claim in the case, and Thorpe objected to it. Continental then moved to compel arbitration.

The bankruptcy court denied Continental's motion to compel arbitration and disallowed its claim, stating it had "discretion in an appropriate case not to send [the issue] to arbitration." The District Court upheld this decision, which was then reviewed de novo by the Ninth Circuit Court of Appeals. This Court, too, agreed, analyzing the topic as a matter of first impression in the Ninth Circuit.

The Federal Arbitration Act 1 establishes "a liberal federal policy favoring arbitration agreements." Thorpe, at 1020 (citation omitted). However, "the Arbitration Act's mandate may be overridden by a contrary congressional command." Id. Finding that the Bankruptcy Code itself does not reflect such a congressional intent, the Court then examined "whether there is an inherent conflict between arbitration and the underlying purposes of the Bankruptcy Code."

As a threshold matter, the Court considered, as have other circuits weighing in on the same issue...