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Without contrary evidence of congressional intent embodied in the Bankruptcy Code, disputes arising out of bankruptcy cases are arbitrable; however, cost-shifting to the party filing bankruptcy can render that portion of the agreement unconscionable, according to a federal bankruptcy court in Pennsylvania.
In In re Herrington, No. 06-14433bif, Adv. 07-0009, 2007 WL 2318135 (Bankr. E.D. Pa. Aug. 8, 2007), Herrington filed for Chapter 13 bankruptcy. Herrington initiated proceedings against creditor Delta and assignee Wells Fargo, bringing claims arising from a loan transaction.
Delta and Wells Fargo sought to compel arbitration of Herrington's claims that Delta had failed to provide certain disclosures required by statute, and that not providing those disclosures amounted to unfair and deceptive conduct under Pennsylvania law. Delta and Wells Fargo alleged that these claims were within the scope of the loan contract arbitration agreement.
Herrington opposed the motion to compel, maintaining that the arbitration agreement was both procedurally and substantively unconscionable, that the claims were a response to a secured proof of claim and were therefore outside the scope of the agreement, and that the bankruptcy court should exercise its legitimate discretion to decline enforcement of an arbitration agreement in a bankruptcy proceeding.
The Court first held that it did not have discretion to refuse enforcement of the arbitration agreement, citing Third Circuit precedent that failed to find any congressional intent to preclude arbitration claims regarding claims arising in bankruptcy cases, or that bankruptcy disputes did not fall within the scope of the Federal Arbitration Act (FAA). Without such Congressional intent, the Court did not have discretion to deny enforcement of the arbitration agreement.
Next, the Court agreed with Herrington that there were elements of unconscionability in the agreement. The Court rejected Herrington's contention that the agreement was unconscionable due to the reservation of judicial remedies associated with foreclosure, noting that this reservation was not sufficient by itself to prove unconscionability.
But, the Court agreed with Herrington that a cost-shifting provision of the agreement was unconscionable. Since Herrington had a "modest income," and that potential liability could reasonably preclude Herrington from bringing an arbitration action, the Court found that the provision deprived Herrington of meaningful choice and unreasonably favored Delta and Wells Fargo. In accordance with a severability provision in the agreement, the Court then struck the cost-shifting provision as unenforceable and severed it from the rest of the agreement.
Finally, the Court declined to reach the question of whether Herrington's claims were arbitrable. The Court acknowledged that arbitrability issues are normally resolved by a court, but found that this agreement explicitly reserved issues of arbitrability to the arbitrator. The Court was therefore bound to refer this issue to the arbitrator's determination per the agreement.
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