Are arbitration clauses enforceable in a bankruptcy case?  Last month, the U.S. District Court for the Eastern District of Arkansas said “yes” and held that state law causes of action that arose out of alleged breaches of contract and other state law theories of liability should be arbitrated as agreed to by the parties in their pre-petition contracts rather than litigated in the bankruptcy court.  Gavilon Grain LLC v. M. Randy Rice (In re Turner Grain Merchandising, Inc.), Case No. 17-00040, D.I. 12 (E.D. Ark., August 16, 2017)

The facts of this case are straightforward.  Turner Grain Merchandising, Inc. (“Turner”) was a grain broker that, among other things, purchased corn, rice and soybeans from farmers and re-sold those commodities to third parties, including Gavilon Grain LLC (“Gavilon”).  Turner eventually encountered liquidity problems and commenced a chapter 11 proceeding to restructure its business.  However, Turner’s attempt to restructure was unsuccessful and the chapter 11 proceeding was ultimately converted to chapter 7.  M. Randy Rice was appointed the chapter 7 trustee (the “Chapter 7 Trustee”) and filed over fifty adversary proceedings seeking to recover Turner’s assets for the benefit of its many creditors.  Included was an adversary proceeding brought against Gavilon. 

The Chapter 7 Trustee pleaded six claims against Gavilon – two for breach of contract, three for unjust enrichment and one for turnover of all amounts that Gavilon allegedly owed as a result of Gavilon’s conduct.  The breach of contract claims against Gavilon alleged that it (i) did not pay for approximately $2.5 million of delivered corn and other charges incurred when shipments were sent to different locations at Gavilon’s request, and (ii) left older contracts with higher grain prices open and selectively paid newer contracts with lower prices.  The unjust enrichment claims were fallback claims that echoed the breach of contract claims.  The turnover claim invoked Bankruptcy Code section 542 and demanded that the amounts allegedly owed (approximately $14 million) as a result of Gavilon’s breaches and unjust enrichment be turned over as property of Turner’s bankruptcy estate.

Gavilon denied any liability and responded with a motion to dismiss and to compel arbitration.  In support of its motion, Gavilon pointed to the underlying contracts and the provision in each that required that all disputes be arbitrated by the National Grain and Feed Association (the “NGFA”),  as well as the strong federal policy in favor of arbitration embodied in the Federal Arbitration Act (the “FAA”).  While the parties stipulated that the arbitration provisions were valid and, absent the bankruptcy, enforceable, the Chapter 7 Trustee argued that the turnover portion of its complaint rendered the action a core proceeding and subject to the bankruptcy court’s exclusive jurisdiction.

Despite the clear mandate of the FAA favoring arbitration and the contingent nature of the turnover claim (i.e., no liability for the state law claims having been proven or admitted), the bankruptcy court sided with the Chapter 7 Trustee and ordered that the dispute be heard in the bankruptcy court.  On appeal, the district court reversed and remanded with instructions that the five state law causes of action be submitted to the NGFA for arbitration, with the turnover claim stayed and left to be pursued in the future if it becomes necessary.

In reaching the decision to reverse the judgment of the bankruptcy court, the district court began by noting that the bankruptcy court’s decision was undermined by a fundamental legal error.  Specifically, because the dispute between the parties was a “rather ordinary contract-related” dispute where the liability was not agreed or otherwise determined, there was no mature debt and no work for the turnover power set forth in the Bankruptcy Code to accomplish.  The larger problem noted by the district court, however, was that the bankruptcy court’s expansive reading of section 542(b) would implicate Stern v. Marshall constitutional issues that should be avoided, if possible, through a narrower reading of the statute.

The district court thereafter identified six independent reasons why the ruling of the bankruptcy court should be reversed.  Those bases included the following:

  • The robust federal policy in favor of otherwise enforceable arbitration agreements demonstrated by the FAA and the Supreme Court’s long history of implementing that policy.
  • The absence of any indication in section 542 that Congress intended to eliminate arbitration (or otherwise supersede the FAA) where a trustee is seeking to recover alleged property of the estate.
  • The lack of any suggestion in the legislative history of section 542 of any attempt to eliminate arbitration where a trustee is seeking to recover money or property that allegedly belongs to the estate.
  • The need to interpret a trustee’s power to seek turnover under section 542, and the bankruptcy court’s power to order turnover, to avoid “constitutional difficulties.” In other words, the expansive reading of section 542 advanced by the Chapter 7 Trustee would require the bankruptcy court to give the final word on state law breach of contract and unjust enrichment claims.  The district court believed that this would necessarily implicate, and potentially run afoul of, the Supreme Court’s ruling in Stern and should be avoided by adopting a narrower reading of the statute.
  • The Chapter 7 Trustee’s complaint against Gavilon was not a bona fide turnover dispute because the claims alleged to support the turnover demand were contingent and unliquidated.
  • The Chapter 7 Trustee’s alternative arguments were similarly unpersuasive. The district court explained that Gavilon did not waive its right to arbitration by filing a proof of claim in the case, and the bankruptcy court’s general authority under 28 U.S.C. §§ 157(b)(2)(A) and (O) was not enough to warrant jurisdiction.

The court’s holding Gavilon Grain is important for any business that regularly includes, or is otherwise subject to, arbitration clauses in contracts.  Resolving a dispute in arbitration may often be preferred to litigating in a bankruptcy court for any number of reasons, including costs and a friendlier or more industry-specific tribunal.  This opinion shows one path that may be available to enforce arbitration clauses in bankruptcy cases, especially where the underlying dispute is over unliquidated state law causes of action.