Discussion of: Highland Capital Management LP v. Dondero (In re Highland Capital Management LP), 21-03003, 2021 Bankr. LEXIS 3314 (Bankr. N.D. Tex. Dec. 3, 2021)
Bankruptcy courts are in disagreement whether to enforce arbitration provisions as opposed to trying the matter in the bankruptcy court. Recently, the Bankruptcy Court for the Northern District of Texas, which is in the Fifth Circuit, disagreed with the bankruptcy courts in the Third Circuit.
In Highland Capital, the reorganized debtor sued the debtor’s insiders in an attempt to collect on some promissory notes payable to the debtor. The defendants were partners per a limited partnership agreement that contained a broadly-worded arbitration clause. During the bankruptcy proceeding, the limited partnership agreement had been rejected as an executory contract1, which turned out to be crucial once the court ruled that the defendants could not compel arbitration.
Regardless of the jurisdiction, bankruptcy judges generally recognize that there is a “strong federal policy” under the Federal Arbitration Action to compel arbitration under the Federal Arbitration Act.
Yet, as noted by the bankruptcy court, the Fifth Circuit has declined to uphold arbitration clauses if the dispute is a “core” proceeding2 and “enforcement of the arbitration provision would irreconcilably conflict with the purposes or goals of the Bankruptcy Code.” See Gandy v. Gandy (In re Gandy), 299 F.3d 489 (5th Cir. 2002); and Ins. Co. of N. Am. v. NGC Settlement Trust & Asbestos Claims Mgmt. Corp. (In re Nat’l Gypsum Co.), 118 F.3d 1056 (5th Cir. 1997).
The bankruptcy court distinguished these Fifth Circuit cases by noting that since the limited partnership agreement had been rejected . Citing U.S. District Court authority which cited Professor Jay W. Westbrook, a noted expert on executory contracts, the bankruptcy court noted that an arbitration agreement is a separate executory contract “…‘since neither side has substantially performed the arbitration agreement at the time of enforcement.’” Highland Capital Management LP v. Dondero (In re Highland Capital Management LP), at 7, citing Janvey v. Alguire, 2014 U.S. Dist. LEXIS 193394 (N.D. Tex. Jul. 20, 2014), aff’d on different grounds at 847 F.3d 231 (5th Cir. 2017), citing Jay Westbrook, The Coming Encounter: International Arbitration and Bankruptcy, 67 MINN. L. REV.595 (1983). Thus, finding that the arbitration clause is a separate executory contract that was rejected, the bankruptcy court held that it could not compel arbitration because specific performance pertaining to enforcing the arbitration clause against a debtor is no longer available after rejection.
- Under what is referred to as the “Countryman test,” an executory contract is defined as “a contract under which the obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.”
- Generally, a core proceeding relates to issues that arise under the U.S. Bankruptcy Code, i.e., the bankruptcy case. For example, core proceedings are the bankruptcy trustee’s duties, matters concerning debtor exemptions, or proceedings to determine, decide or recover fraudulent transfers. Non-core proceedings, on the other hand, are issues that arise in a bankruptcy case that are not technically bankruptcy, i.e., a divorce, a car accident, or a breach of contract.