Any person in business has at one time or another received the dreaded notice from the Bankruptcy Court that a debtor or customer has filed for bankruptcy and that what was previously a business relationship that can offer some benefit is now not only defunct, but the odds of recovery are probably nil. As described in our article on Bankruptcy, once bankruptcy is filed the Federal Bankruptcy Court assumes full jurisdiction as to all economic matters effecting the bankrupting party, all pending or possible legal actions or remedies are stayed, and, indeed, the creditor can face severe sanctions from the court if relief is sought outside the jurisdiction of the Bankruptcy Court. Existing obligations may be entirely nullified by the court with creditors often paid pennies on the dollar. A common reaction of the creditors was to simply throw the notice in the waste basket and write off the debt.
Real Estate Transactions. But even unsecured creditors have found that an active and intelligent participation in the bankruptcy proceeding can yield important results. As one client put it, filing bankruptcy no longer stops all efforts to collect…merely changes the forum of collection.
Obviously a rigid cost benefit analysis must be conducted to determine the possible net recovery but, at the least, the creditor is well advised to investigate the matter with alacrity and obtain both legal and tax advice as to the potential upside and downside of pursuing the claim.
And this leads to the question of whether the various cost saving business/legal tools the wise business person has adopted can still be utilized in bankruptcy. The Bankruptcy Courts are jealous of their powers and not inclined to allow the intricate safeguards any good business attorney builds into contracts to interfere with the plans the Court may develop to “save” or protect the bankrupt business. However, a new spirit is developing in the Bankruptcy Courts and the creditors are no longer necessarily seen as third parties whose only interest is to avoid the valid laws of bankruptcy. As more and more cases are filed in which solvent companies are using the Bankruptcy Courts to revamp obligations, the Bankruptcy Courts are seeing themselves as applying equitable principles to ensure the fair allocation of obligations and responsibilities and to concentrate increasingly on protecting the rights of the creditors as well.
Nowhere is this more clear than in the attitude of the Courts to use of arbitration. As the reader can determine by reviewing our articles on Arbitration and on Arbitration and Mediation, this mode of recovery allows parties to efficiently and rapidly determine rights and duties without the great expense of court trials. Quite often, a party facing a dire consequence during an arbitration, or knowing that another party is about to commence proceedings in arbitration, will leap into the Bankruptcy Courts and hope that the greater expense of a trial in that forum will cause the other party to give up the claim.
But the Bankruptcy Courts are rethinking their approach to the enforceability of arbitration and mediation clauses in Bankruptcy and that is the theme of this article.
ADR IN THE BANKRUPTCY COURTS
If a claim of a creditor is contested by the Trustee in bankruptcy, the resulting trial is normally termed an “adversary proceeding.” As the number of bankruptcy filings has increased and the size and complexity of cases, adversary proceedings and contested matters have grown, ADR has assumed a more prominent role in bankruptcy disputes. Discussions of the topic have fallen into two broad areas.
1. The first intersection between bankruptcy and ADR has not concerned the use of alternative resolution methods for specifically bankruptcy problems, but rather whether arbitration provisions in pre-petition contract between the debtor and a third party are enforceable. Early cases were generally hostile to enforcing pre-petition arbitration agreements on the ground that Congress had intended to concentrate all debtor-related adjudication before the Bankruptcy Court. Subsequent legislative and judicial changes undermined the basis for this position. It now appears to be clearly established that a Bankruptcy Court has no discretion but to uphold otherwise valid arbitration clauses in noncore or "related to" matters. In core proceedings, the growing judicial consensus appears to be that a Bankruptcy Court has discretion to deny the enforcement of a pre-petition arbitration clause if, but only if, the dispute involves a substantive right created by the Bankruptcy Code itself, or if the rights of the pre-petition debtor are not at issue.
2. The second general area of concern has been the use of court-annexed ADR as part of the bankruptcy process itself. Proceedings under the Bankruptcy Code, particularly the reorganization chapters, are themselves a form of collective alternative dispute resolution, and it is surprising that the use of court-annexed ADR is relatively new to bankruptcy. Starting with the creative use of ADR on an ad hoc basis in cases involving mass claims and with pilot programs in certain districts, the use of nonbinding ADR as a means of reaching agreement now has a firm foundation both in statutes and in procedural rules. Some Bankruptcy Courts have their own local rules dealing with mediation as a means of achieving settlement, and other Bankruptcy Courts employ the local ADR rules of the district court. For mediation to work, however, confidentiality is required. Just how this should be achieved has been the subject of some dispute. Furthermore, the parties must mediate in good faith. Just what constitutes "bad faith mediation" and how it should be dealt with deserves attention. Settlements achieved through ADR require Bankruptcy Court approval. Once approved, a compromise achieved by mediation is almost