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In ordering arbitration of a core bankruptcy proceeding, a bankruptcy court in Alabama held that a bankruptcy court cannot refuse to enforce an otherwise applicable arbitration agreement unless there is an "inherent conflict" with the underlying purposes of the Bankruptcy Code.
In In re Cooley, No. 06-40905-JJR-13, 2007 WL 512758 (Bankr. N.D. Ala. Feb. 14, 2007), Cooley bought a pick-up truck on an installment contract. Immediately following the sale, the dealership assigned the installment contract to Wells Fargo Financial (Wells Fargo).
A year and a half later, Cooley filed for bankruptcy, prompting Wells Fargo to file a proof of claim for the unpaid balance on the installment contract. In response to Wells Fargo's proof of claim, Cooley initiated an adversary proceeding against Wells Fargo, alleging violations of the Truth in Lending Act (TILA).
Wells Fargo responded to the adversary proceeding by filing a motion to compel arbitration in accordance with the installment contract. In opposing the motion, Cooley argued that the adversary proceeding was not subject to arbitration because it was a core bankruptcy proceeding.
The Court agreed that the adversary proceeding constituted a core bankruptcy proceeding, meaning a bankruptcy court could adjudicate the matter without involving the district court. However, the Court did not agree that a bankruptcy court may refuse to order arbitration of any matter that constitutes a core bankruptcy proceeding. The Court thus joined the Second, Third and Fifth Circuit Courts of Appeal in rejecting the core versus non-core test for determining whether a bankruptcy court may refuse to enforce an otherwise applicable arbitration agreement.
Instead of adopting the core versus non-core test, the Court held that a bankruptcy court may refuse to enforce an otherwise applicable arbitration agreement "only if, after analyzing the law and circumstances of each particular proceeding, the court finds a conflict between the underlying purposes of the Bankruptcy Code and resolving the proceeding through arbitration." The central aspect of this inquiry is whether the proceeding derives from the Bankruptcy Code (e.g., an alleged violation of the automatic stay imposed by 11 U.S.C. § 362(a)) or from some other legal authority (e.g., an alleged violation of TILA).
Applying this standard, the Court found that it had no authority to deny enforcement of the arbitration clause in the installment contract because arbitration of the adversary proceeding would not conflict with the underlying purposes of the Bankruptcy Code. The Court reasoned that there was no conflict mainly because the adversary proceeding derived from TILA rather than the Bankruptcy Code.
Under the majority rule followed by the Court in this case, the core versus non-core distinction is relevant only insofar as core status is a necessary condition for a bankruptcy court to deny enforcement of an otherwise applicable arbitration agreement. According to the minority position, which favors the use of a bright line rule even though it is overly broad, core status is a sufficient condition for a bankruptcy court to deny enforcement of an otherwise applicable arbitration agreement. See, e.g., In re Brown, 354 B.R. 591 (D.R.I. 2006).
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